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Other Articles
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IRA
What Roth Hath, Traditional Hath Not
By Stephen May
Financial Advisor, Raymond James & Associates, Inc.
The Taxpayer Relief Act of 1997 introduced a new Individual Retirement Account (IRA) called the Roth IRA. The primary inducement to make contributions to the new Roth IRA is that distributions are tax-free if certain conditions are met. One drawback to the Roth IRA is that contributions to the account are never deductible. The passage of the Economic Growth and Tax Relief Reconciliation Act in 2001 provided for increased contributions going forward.
For 2006, an individual may contribute up to $4,000 to a Roth IRA (less any contribution made to a traditional IRA). This amount will eventually be raised to $5,000 in 2008. In addition, EGTRRA established a catch-up provision. Individuals who have attained age 50 or over during the tax year may contribute an additional $1,000.
Contributions to Roth IRAs are not deductible and must be in cash when made. In addition, unlike regular IRAs, there is no age restriction on making contributions. The AGI threshold for contributing to a Roth IRA is $95,000 for single individuals and $150,000 for married individuals filing a joint return. For single filers, the allowed contribution is phased out for AGI between $95,000 and $110,000. For married individuals, the allowed contribution is reduced proportionately if AGI is between $150,000 and $160,000. No Roth IRA contributions are allowed if an individual is married and files separately.
The earnings attributable to contributions accumulate on a tax-deferred basis and become tax free and penalty free upon withdrawal providing the Roth IRA has been in effect for at least five years and the taxpayer:
has attained the age 59 ½,
dies or becomes disabled, or
is a "qualified first-time home buyer" using the distribution in the purchase of a primary residence.
Distributions from a Roth IRA that has been in effect for at least five years and are taken for any of the above reasons are known as “qualified distributions.” Qualified distributions are not includible in taxable income. Now for the tricky part, distributions that are taken from Roth IRAs before any of the events specified above are met are deemed “non-qualified distributions.” Non-qualified distributions will be taxable and potentially exposed to the 10% penalty to the extent the distribution includes earnings.
Unlike traditional IRAs, there is no requirement to begin distributions from a Roth IRA at age 70 ½. An individual can continue to defer tax on Roth IRA earnings for their entire lifetime. The traditional IRA required minimum distribution rules do apply to the beneficiary of a Roth IRA following the death of the Roth IRA participant. Thus, a beneficiary can continue to defer tax on Roth IRA earnings but the beneficiary is subject to minimum distribution requirements.
A traditional IRA may roll over (or simply convert) all or part of the assets into a Roth IRA if an individual’s AGI is not more than $100,000 for the year of the conversion (or rollover). The $100,000 AGI limit is determined without regard to any amount included as a result of the conversion and is applicable to single and joint taxpayers. Withdrawals from a traditional IRA that are converted into a Roth IRA are not subject to the 10% penalty tax. However, the full amount of the conversion may be subject to taxation.
In deciding whether to make contributions to a traditional IRA or a Roth IRA, a taxpayer should take into account a number of factors. Some of these factors are eligibility to make contributions, the number of years to accumulate earnings, the time projected to begin distributions and current versus future tax brackets. A taxpayer must consider whether the current deduction of contributions to a traditional IRA is more valuable than the future recovery of earnings tax free.
Of course, this brief article is no substitute for a careful examination of all of the advantages and disadvantages of this matter in light of your unique personal financial circumstances. Before implementing a financial planning strategy, contact and consult with your Financial Advisor and tax professional.
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