Brushing Up on the Facts: Roth IRAs

“Financial security in retirement doesn’t just happen.  It takes planning and commitment, and yes, money.”  According to the United States Department of Labor, one of the “Top 10 Ways to Prepare for Retirement” is to put money into an Individual Retirement Account, oftentimes simply referred to as an IRA.  With two types of IRAs to choose from, the Traditional and Roth, it’s important to determine which is best for you. With that said, we encourage you to brush up on the facts of Roth IRAs.

Eligibility

Eligibility for contributing to a Roth IRA is restricted by annual household income (Modified Adjusted Gross Income) only.  Individuals filing as Single, can contribute the maximum amount if their income is below $117,000 and a reduced amount if their income is between $117,000 and $132,000.  If their income is above $132,000, they cannot contribute to a Roth IRA for the current tax year.  Individuals filing as Married Filing Jointly, can contribute the maximum amount if their income is below $184,000 and a reduced amount if their income is between $184,000 and $194,000.  If their income is above $194,000, they cannot contribute to a Roth IRA for the current tax year.  A “non-working” spouse can contribute to a Roth IRA as long as the annual household income is $194,000 or less.

Contributions

Eligible individuals can contribute to a Roth IRA from January 1^st of the current tax year to April 15^th of the following tax year.

The maximum annual contribution is limited to the lesser of $5,500 or 100% of taxable compensation. Individuals age 50 or older are allowed to make an additional $1,000 contribution that is oftentimes referred to as a Catch-Up Contribution.  This is allowed to assist individuals who are nearing retirement age and are behind in saving for retirement. However, it is allowed for all individuals age 50 or older.

The maximum annual contribution combines contributions made to both Traditional and Roth IRAs.  For example, an individual under age 50 can contribute $2,750 to a Traditional IRA and $2,750 to a Roth IRA, but not $5,500 to both a Traditional IRA and $5,500 to a Roth IRA.

Contributions to a Roth are not tax deductible.

Don’t make contributions over and above the limits outlined above! Excess contributions are taxed at 6% per year for as long as the excess contributions remain in the IRA.  An individual has until the due date of his or her individual income tax return, including extensions, to withdraw the excess contributions and any earnings on the excess contributions.

Distributions

Qualified distributions are tax-free.  But what is a qualified distribution?

For Assets in a Roth IRA that were converted from a Traditional IRA:

• If the assets have been held in the Roth IRA for 5 years, there will be no income taxes or early withdrawal penalty taxes.
• If the assets have not been held in the Roth IRA for 5 years, but distributions are made for any of the following reasons, there will be no income taxes or early withdrawal penalty taxes:
  1. Attainment of age 59 ½
  2. Death
  3. Disability
  4. First home purchase for the Account owner or his or her children or grandchildren (up to $10,000 per lifetime)
  5. Medical expenses
  6. Medical insurance premiums while unemployed
  7. Substantially equal periodic payments
  8. Higher education expenses for the Account owner, his or her spouse, children, grandchildren, or great-grandchildren
• If the assets have not been held in the Roth IRA for 5 years and are distributions not for any of the above reasons, there will be no income taxes, but there will be early withdrawal penalty taxes (10%).

For Earnings in a Roth IRA:

• If the assets have been held in the Roth IRA for 5 years and are for any of the above reasons from 1 to 4, there will be no income taxes or early withdrawal penalty taxes.
• If the assets have been held in the Roth IRA for 5 years and are for one of the above reasons from 5 to 8, there will be income taxes but no early withdrawal penalty taxes.
• If the assets have been held in the Roth IRA for 5 years and are not for any of the above reasons, there will be income taxes and early withdrawal penalty taxes.
• If the assets have not been held in the Roth IRA for 5 years and are for any of the above reasons, there will be income taxes but no early withdrawal penalty taxes.
• If the assets have not been held in the Roth IRA for 5 years and are not for any of the above reasons, there will be income taxes and early withdrawal penalty taxes.

Distributions from a Roth IRA are assumed to be made in the following order: contributions, (which are always tax free), conversions, and earnings.

Roth IRAs are not subject to Required Minimum Distributions.  However, they are subject to the following rules at the Account owner’s death:

• The Account must be distributed within 5 years of the owner’s death, or
• The Account must be distributed over the life expectancy of the designated beneficiary with distributions commencing prior to the end of the calendar year following the year of the owner’s death.
• If the sole beneficiary is the owner’s spouse, the spouse may delay distributions until the Account owner would have attained age 70 ½ or may treat the Account as his or her own (by rolling it into his or her own Roth IRA) eliminating any required distributions during his or her lifetime.

To learn more about preparing for retirement, feel free to contact us with any questions you may have.  We would love to be your partner in the process of planning for your retirement!