Roth IRAs offer distinctive advantages over Traditional IRAs. With a Traditional IRA, distributions after age 59½ are generally taxed as ordinary income, while qualified distributions from a Roth IRA are free from federal income taxes. Since qualified distributions can be taken at any time without taxes or penalties, Roth IRAs may give you more flexible access to your savings than Traditional IRAs. (Converted assets may be withdrawn without taxes and penalties under certain circumstances.) Unlike Traditional IRAs, with a Roth IRA, there's no age limit on contributions and minimum distributions are not required, so you can keep your money in your account as long as you live. Roth IRA contributions, however, are made on an after-tax basis.
For 2007, if you contribute only to a Roth IRA, the maximum contribution is $4,000 or your taxable compensation, whichever is less. If your modified AGI (adjusted gross income) is above a certain amount, your contribution limit may be reduced. Your maximum contribution may be further reduced by any contributions to Traditional IRAs on your behalf (other than employer contributions under a SEP or SIMPLE IRA).
Contribution Limit Schedule:
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), provides for increases in contribution limits over the next several years. The limits for Traditional and Roth IRAs are:
Year
Amount
2002-2004
$3,000
2005-2007
$4,000
2008 and beyond
$5,000, plus potential cost of living adjustment (COLA) increases in $500 increments beginning in 2009
Additionally, EGTRRA gives people age 50 and older an opportunity to contribute more than the basic annual IRA contribution limit:
No. Roth IRA contributions are not deductible. Since regular contributions are made after taxes, you can access them anytime without taxes or penalties.
Which distributions from a Roth IRA are not taxable?
Certain distributions from your Roth IRA are not included in your gross income and are not subject to federal income tax. These include:
Return of regular contributions that exceed the contribution limit and are returned, along with any earnings on the contributions (which are taxable), before your tax return due date
Qualified distributions (as defined in this section), that have remained in the Roth IRA for five years or more
Distributions from your Roth IRA that you roll over tax free into another Roth IRA
Generally speaking, a qualified distribution is any distribution from your Roth IRA (or amounts converted from a Traditional IRA which were subject to tax), which have been in the account for at least five years AND are made:
on or after the date you reach age 59½,
because you are disabled,
to a beneficiary or to your estate after your death, or
to buy, build, or rebuild a first home (up to a $10,000 lifetime limit).
A distribution is not a qualified distribution if it is made within five years of a contribution—or if it is made after the five-year period, but fails to satisfy any of the four conditions that would make it a qualified distribution.
If you make a withdrawal from your Roth IRA that is not a qualified distribution, part or all of the withdrawal may be taxable. In some cases, state and local taxes may apply to distributions that are free from federal income taxes.
A special circumstance to note: Contributions withdrawn before your tax filing date are treated separately by the IRS. If you made excess contributions to your Roth IRA, you may withdraw them without federal income tax by the due date of that year's return (including extensions). However, this is allowed only if you also withdraw any interest or other income earned on the contributions. Neither the contributions nor the earnings, if any, are qualified distributions, and any earnings must be included in income for the year the contribution was made.
When can I take money out of a Roth IRA without penalties?
Generally speaking, you may withdraw regular contributions anytime without penalties. In addition, qualified distributions of earnings are free from federal income tax and no penalties apply.
If you contribute more to your Roth IRA than is allowed, a 6% excise tax may apply to the excess contribution. If you withdraw the excess amount and any related earnings before the due date of your federal income tax return (with extensions), however, the amount will be treated as if it was never contributed.
If you convert a Traditional IRA to a Roth IRA, you may not withdraw assets from the account within five years of conversion without the earnings being subject to federal income tax. In addition, you may incur a 10% penalty for early withdrawal.
If you receive a distribution that is not a qualified distribution, you may have to pay a 10% early withdrawal penalty, subject to certain exceptions. These exceptions include: withdrawals after attaining age 59½, withdrawals related to disability, certain medical expenses or medical insurance costs, qualified higher-education expenses, first home purchases, and distributions that are part of a series of substantially equal periodic payments made for your life or life expectancy (or the joint lives or joint life expectancies of you and your designated beneficiary).
How can I tell which types of contributions/earnings I'm withdrawing?
If you make a withdrawal from your Roth IRA that is not a qualified distribution, part of the withdrawal may be taxable. To help you determine the correct tax, there is a set order in which contributions and earnings are considered to be withdrawn from your Roth IRA:
Regular contributions
Amounts converted from a Traditional IRA, which were subject to tax, on a first-in, first-out basis
Amounts converted that were not subject to tax (nondeductible Traditional IRA contributions)
Conversions from either a Traditional, SEP, or SIMPLE IRA
Recharacterizations of contributions made to one IRA as having been made directly into a different IRA
Rollovers of amounts distributed from one Roth IRA and reinvested in another within 60 days
Trustee-to-trustee transfers from one Roth IRA to another
Conversions to a Roth IRA may be desirable for investors who prefer qualified distributions that are free from federal income tax. The tax consequences of converting to a Roth IRA may be substantial, and conversion rules (including reconversion provisions) are complex. A failed conversion (due to higher-than-anticipated income or an unexpected change in filing status) may have adverse consequences, including a 6% excise tax on any excess contribution not withdrawn from the Roth IRA, the need to include Traditional IRA distributions in gross income, and a 10% penalty on any early withdrawals. These penalties may be avoided if you are able to recharacterize your contributions. Conversions are not permitted if your AGI exceeds $100,000 or if you are married filing separate returns. Beginning in 2005, required minimum distributions from Traditional IRAs no longer count toward the $100,000 AGI limit. Therefore, many people over age 70 1/2 who were previously ineligible to convert to a Roth IRA may now have an opportunity to do so.
Recharacterizations may allow you to treat contributions to one type of IRA as a contribution to a Roth IRA, or vice versa. Even if the contribution to the first IRA would have been deductible, if it is recharacterized as a Roth IRA contribution, no deduction will be allowed.
Rollovers from a Roth IRA allow you to make tax-free withdrawals of part or all of the assets from one Roth IRA if you contribute them to another Roth IRA within 60 days. Most of the Roth-to-Roth IRA rollover rules are similar to those for Traditional IRAs.
Trustee-to-trustee transfers allow money to move directly from one Roth IRA to another, even at a different financial institution. In this type of transfer, you do not actually receive the distribution.
For more information about Roth IRA provisions, distributions, and taxes, please consult with your tax advisor.
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