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Roth IRA Accounts

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.

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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 70).

Contribution Limits
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.

Contribution Amounts
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 Phaseout below).

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 annual limit.
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 income.
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.

Contribution Phaseout
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 after-tax dollars.
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 70.
5. Contributions don't need to be made every year.
6. Contributions may be made even if you participate in another retirement plan.
7. Traditional IRAs may be rolled over into a Roth IRA.
8. Special creditor protection may be available.

Negatives of the Roth IRA

1. Contributions are not tax deductible.
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.

Timing of Distributions
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 70, 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
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 or
4. Pay income tax, but no penalty, on the distributed earnings or
5. Pay income tax and a penalty on the distributed earnings

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.

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:

a.You are at least age 59 or
b.You are using the funds (up to $10,000) for a first-time home purchase or
c.You are disabled or
d.Your beneficiaries are receiving distributions after your death.

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 amount is a lifetime limit and is not an annual limit.

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.

Beneficiary Designations
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 assets.

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 named.

Creditor Protection
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 different.

Consulting with an attorney for guidance on the creditor protection issue may be helpful.

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:
If you'd like more information about how diversified investment advisors can help you achieve your financial objectives through personalized wealth or retirement and risk management strategies, please contact us. We welcome the opportunity to discuss your unique needs and how we may best meet them.

This page (formatted for versions 10.0 and higher of Internet Explorer) is updated regularly so check in from time-to-time to see new articles and updates. You can click on any underlined words on each page to see a specific wealth management topic in the left margin of each page.

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.

The information contained in this web site is neither an offer nor solicitation of any security or service.


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