Roth IRAs
With a few important exceptions, a Roth individual retirement account (IRA) is essentially a nondeductible traditional IRA. Roth IRAs are also generally subject to the same rules as traditional IRAs. For example, the contribution limits for Roth IRAs and traditional IRAs (deductible and nondeductible) are equally $5,000 for 2008 ($4,000 for 2005 through 2007), with an additional $1,000 contribution allowed for those age 50 and above in 2006, 2007 and 2008.
Despite the many similarities, however, Roth IRAs do have a number of unique features and requirements that you should be aware of when choosing individual retirement arrangements. The most important ones are as follows:
- Qualified distributions from a Roth IRA are not includible in income and, therefore, tax-free.
- Contributions can be made to your Roth IRA regardless of your age.
- There are no required minimum distributions that must be made from a Roth IRA.
- Eligibility to contribute to a Roth IRA is subject to special limits.
Qualified distributions. To count as a qualified distribution, a Roth IRA distribution cannot be made before the end of the five-tax-year period beginning with the first tax year for which the individual (or the individual's spouse) made a contribution to the Roth IRA. In addition to the five-year holding period, a qualified distribution can only be made if it is:
- on or after the date the individual reaches age 59.5
- to a beneficiary or an individual's estate on or after the individual's death
- attributable to the individual being disabled
- used to pay for qualified first-time homebuyer expenses
Distributions that do not meet the above requirements are considered nonqualified distributions. The Roth IRA holder will owe income taxes on any earnings withdrawn. However, the 10 percent early withdrawal penalty tax that applies to traditional IRAs generally does not apply to Roth IRAs except in cases of failed conversions from a traditional IRA.
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Did You Know?
Under a change made by the Pension Protection Act of 2006, beginning in 2008, distributions from tax-qualified retirement plans, tax-sheltered annuities, and 457 plans can be rolled over directly into a Roth IRA. However, such rollovers will be subject to the AGI and filing status restrictions that apply to rollovers from a traditional IRA into a Roth IRA, until the repeal of the restrictions takes effect after December 31, 2009.
For rollovers in 2010, the taxpayer will recognize the distribution amount in income ratably in 2011 and 2012 unless the taxpayer elects to recognize it all in 2010. No special provision is made for years after 2010, so taxpayers making rollovers in 2011 and thereafter will have to recognize the entire amount of the distribution as income in the tax year the distribution takes place.
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The following two related topics also deserve more in-depth discussion, but will be examined separately:
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Did You Know?
As if having Roth IRAs were not enough, beginning in 2006, 401(k) plans and 403(b) plans can incorporate a "qualified Roth contribution program" under which participants may elect to have all or a portion of their elective deferrals to the plan designated as after-tax Roth contributions.
Similar to Roth IRAs, earnings on the contributed amounts would also grow tax-free and would not be subject to income tax upon distribution. On the down side, separate accounting and recordkeeping for Roth contributions would be required. This may make offering the Roth contribution option an unattractive feature for employers to add to their plans. Only time will tell, however, whether this is an option that will see widespread use among employer plans.
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