Roth IRA Accounts
The Roth IRA was created effective January 1, 1998 as part of the Taxpayer Relief Act of 1997. Congress made the Roth option permanent in 2006. The purpose of this new IRA is to encourage retirement saving.
The two most common types of IRAs (individual retirement accounts) are the Roth IRA and the traditional IRA. An IRA is a personal retirement fund. What is special about Roth IRAs
is that distributions may be income tax-free. However, contributions to a Roth IRA are made with after-tax dollars and no deduction is received for the contributions.
The general tax rules described below are the federal income tax rules as of January 1, 2014 and may be subject to exceptions. Although most states now allow Roth IRAs, check your
state (and local) income tax rules on Roth IRAs. Finally, since tax laws may (and probably will) change from time to time, always check with your tax advisor before making major
decisions regarding your IRAs.
You need to have earned income (e.g., wages, salary, net self-employment income or taxable alimony) to be eligible to contribute to a Roth IRA. Contributions may be made at any
age (unlike contributions to a traditional IRA which must stop in the year you reach age 70½).
Although contributions are based upon your earned income, the amount of your contribution depends upon your income level and your marital status. Participation in an employer sponsored
retirement plan such as a 401(k), pension or profit sharing plan does not affect your Roth IRA contribution limit.
You can contribute to a Roth IRA up to the lesser of:
1. $5,500 or
2. 100% of your earned income. The lesser of
these amounts is subject to a further reduction or
elimination depending upon your income level (see Contribution
a. You can contribute up to the lesser
of (1) $5,500 or (2) 100% of your earned income. The
$5,500 per person annual contribution limit is a maximum
that applies to the total contributions to both traditional
and Roth IRAs. For example, you could contribute $2,750
to a Roth IRA and $2,750 to a traditional IRA, making
a total of $5,500 in IRA contributions. However, you
could not contribute $3,000 to one type and $2,750 to
the other since that sum would be larger than the $5,500
b. Married couples can contribute up to a total
of $11,000 per year. If you're married and only one
of you is working (or has a high enough income), then
the non-working/lower-earning spouse can also contribute
up to $5,500, provided the combined contribution (e.g.,
$5,500 for each of you) is not larger than the earned
c. Individuals don't have to contribute every
year. You decide which years you want to contribute
to an IRA.
d. If you are 50 years old or older this year, you're
allowed to contribute an additional $1,000 under the "catch-up"
provision bringing the total contribution limit to $6,500.
Single persons with a modified adjusted gross income of less than $114,000 may
make the maximum contribution of $5,500.
Married couples filing jointly with a modified adjusted gross income of less
than $181,000 may make the maximum contribution of $11,000. The contribution level of a married person filing separately
(who lived at least part of the year with his or her spouse) is reduced as
income goes between $0 and $11,000 and then it is eliminated completely (however,
a married individual who has lived apart from his or her spouse for the entire
taxable year and who files separately is treated as not being married and is
under the single person rules described above).
You are always 100% vested with a Roth IRA.
Benefits of the Roth IRA
1. Contributions up to $5,500 per year (up to $11,000 for
married couples, including non-working spouses). Contributions are made with
Negatives of the Roth IRA
2. All distributions may be income tax free. Earnings and contributions
may grow tax free without any reduction for income tax each year.
3. Contributions can be made at any age.
4. Distributions don't have to start at age 70½.
5. Contributions don't need to be made every year.
6. Contributions may be made even if you participate in another retirement
7. Traditional IRAs may be rolled over into a Roth IRA.
8. Special creditor protection may be available.
1. Contributions are not tax deductible.
Timing of Distributions
2. If your income is too high, you may not be eligible to make a contribution.
3. If your income is too high, you may not be able to convert another
IRA into a Roth IRA.
4. You can't use distributions from a Roth IRA to satisfy the minimum
distribution rules of traditional IRAs.
5. You can't borrow from an IRA.
Unlike traditional IRAs, you do not have a mandatory distribution deadline with
a Roth IRA. Where traditional IRAs require distributions to start no later than
April 1 of the year after the year you reach age 70½, the absence of such a deadline
allows a Roth IRA to continue to grow income tax free.
Income Taxes and Penalties
Under federal income tax law, there are five possible results for distributions
from a Roth IRA.
1. Pay no income tax or penalty on the distributed earnings
or contributions or
When you consider distributions from a Roth IRA, always keep these two categories
in mind: contributions and earnings. As you'll see below, the rules for distributing
contributions and the rules for distributing earnings may be same or they can
differ depending upon the circumstances.
2. Pay no income tax or penalty on the distributed contributions or
3. Pay no income tax but pay a penalty on the distributed contributions
4. Pay income tax, but no penalty, on the distributed earnings or
5. Pay income tax and a penalty on the distributed earnings
Two Requirements for Distributions of Contributions and Earnings to be Income
Tax and Penalty Free
A distribution of earnings and your contributions from your Roth IRA can be made
free of any federal income tax and a penalty if:
1. the distribution is made on or after your Roth IRA has
been open for at least 5 taxable years and
2. any one of the following apply:
The term "first-time home purchase" means
you didn't own part or all of a principal residence in
the two-year period before buying the new house. This $10,000
is a lifetime limit and is not an annual limit.
a.You are at least age
b.You are using the funds (up to $10,000) for a first-time home
c.You are disabled or
d.Your beneficiaries are receiving distributions after your death.
The five-year rule has some twists and turns, too. A contribution is considered
to have been made on the first day of the tax year to which it applies. So, for
example, a contribution made by April 15, 2000 for your 1999 calendar year income
tax return would be treated as a January 1, 1999 contribution.
Legal and tax advice is useful when determining how to complete beneficiary designations.
Properly completed designations can help save estate (death) tax, avoid probate,
allow better income tax opportunities and avoid creditor claims on retirement
Extra care needs to be taken in naming trusts as a beneficiary of most retirement
assets in case of a death. Sometimes, naming trusts as a beneficiary can trigger
income tax sooner than it would otherwise be owed and reduce the amount ultimately
shielded from death tax.
Note that many plans require the participant's spouse to be the beneficiary,
unless the spouse provides written permission for another beneficieary to be
Retirement plans and accounts may have special creditor protection under federal
and/or state laws. Different types of plans and accounts may have varying degrees
of protection. State protection rules may also vary from state to state.
If you convert from one type of plan to another (e.g., from a traditional IRA
to a Roth IRA), you may be changing how much protection you have. This may be
also be the case if you move to another new state where the new state rules are
Consulting with an attorney for guidance on the creditor protection issue may
Estate and Death Taxes
Retirement assets are added to your other assets and may be subject to federal
and/or state death (estate) tax. It depends upon the size of your overall estate
and the estate planning done for you. Consult with your advisor about ways to
defer or avoid estate tax.
For more information:
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Charles M. Bloom, Registered Principal offers securities
and advisory services through Centaurus Financial, Inc. - Member FINRA and SIPC - 775 Avenida Pequena, CA, 93111 (mailing address: 3905 State Street Suite 7173, Santa Barbara, CA, 93105) - CA Life Insurance License No. 0A52786 - Centaurus Financial, Inc. and Shoreline Wealth & Investment Management are not affiliated companies.
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