Tuesday, May 17, 2011

Individual Retirement plans - Roth IRA


The Roth Individual Retirement account came into existence in 1997 following the Tax Payer Relief Act. It was sponsored by Senator William V. Roth, Jr. of Delaware.  The Roth individual retirement plan uses post tax contributions to fund an account that does not pay any additional taxes upon retirement distribution. The structure of Roth IRA is different from that of the traditional IRA that uses pretax contributions to fund an account.

Roth IRA does not restrict you from participating on any employer provided retirement plans, because contributions made to a Roth IRA are non-deductible. At first, IRAs were allowed only for employees who were not covered by a qualified pension plan of their employer. Roth IRA accounts are open to anyone, with the allowable modified adjusted gross income.

Eligibility rules

If you want to contribute to a Roth IRA, you need to get some kind of compensation in the form of wages, professional fees, salaries and/or bonuses. The only qualifying rule for Roth IRAs is the compensation rule. Unlike traditional IRA, Roth IRA allows you to make contribution at any age. You can contribute to this retirement at anytime for a given calendar year until the due date of your tax return (anytime between January 1 of a year and April 15 of the successive year).

Another excellent feature of the Roth IRA is that it allows your spouse to contribute. Your spouse can make contributions, even if he/she has little or no compensation, provided you file a joint return.

Roth IRA compensation limits

There is an income limit for making contribution to Roth IRA plan. In 2011, your MAGI should be less than $105,001 to make a full contribution, provided you are single or married but filing separately (and did not live with your spouse during the year). Partial contribution is allowed, if your MAGI is more than $105,000, but less than $122,000. If your income is more than $122,000, you cannot make a contribution.

If you file jointly and have a MAGI up to $169,000, you can make a full contribution. Contribution is phased out, if your income is more than $169,000 but less than $179,000. If your income exceeds $179,000, you cannot make a contribution to the Roth retirement plan.

If your are married and live with your spouse,, but filing tax returns separately, you cannot make a contribution to a Roth IRA, if your adjusted gross income is more than $10,000.

Benefits of contributing to a Roth retirement plan –

  • Roth IRA allows you to enjoy tax free earnings, provided certain conditions are met.
  • You can become eligible for tax credits
  • You can get tax free distributions. You need not pay any tax amount
  • You can continue making contributions as long as you earn an income.
  • There are no required minimum distributions before death.
Roth IRA withdrawal rules

IRA contribution withdrawal is always free from tax and federal tax penalty. For withdrawing conversions, a taxable portion of converted amount is treated as income. If converted amount is withdrawn before five years since latest conversion, you will incur federal tax penalties.

Purposes of traditional and Roth IRA plans

If you find it difficult to determine which retirement plan is right for you, you must know the purposes of both the traditional and Roth IRA.

Traditional IRA

The main purpose of traditional individual retirement plan is to make an investment for retirement. However, there are certain ways you can use the money earlier. Traditional IRA allows special purpose withdrawals under specific conditions. The qualified withdrawals are penalty free, but the tax deductible contributions and earnings, if any will be taxed as normal income at your current tax rate.

Traditional IRA offers tax benefits at all times. It works well for some investors. All or some of your contributions may be tax deductible on your tax return. Tax deductibility is determined on the basis of your adjusted gross income, tax filing status and whether you or spouse take part in an employer sponsored retirement plan.

 Purpose of Roth IRA

Contributions made to Roth retirement plan are not tax deductible. However, it offers many other benefits, which make it an ideal IRA for many. Roth IRA offer tax free earnings as well as flexibility. If your account is at least five years old and your age is 59 ½, you may be able to withdraw your earnings tax free and penalty free anytime.

Roth IRA does not require you to take money out of the account at any age. On the other hand, traditional IRA requires you to take a minimum distribution from your account from the age of 70 ½. Otherwise, you will face a tax penalty of 50% of the amount you did not use. Roth IRA allows you to make contribution as long as you earn. Moreover, the beneficiaries of the Roth retirement plan account will not have to pay any income tax on the assets in your account provided it is open for at least five years.

Roth IRA is ideal for you, if you have a long time for retirement and do not want to get any immediate tax deduction. It is perfect, if you want to roll over any portion of your retirement plan money, due to situations like changing job or retirement.

Traditional IRA may be ideal, if you want to roll over any non-Roth portion of retirement plan money, while changing jobs or retiring. If you are eligible for a current tax deduction or expect that your tax bracket will be low in retirement, you can go for traditional IRA. 

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