A Few Pointers to Help You Choose
The Roth IRA, created in the tax law signed last month, will allow taxpayers after Jan. 1, 1998, to deposit up to $2,000 of earned income annually into this tax-advantaged retirement savings account. Contributions are not tax-deductible; however, all withdrawals by taxpayers who are at least 59 1/2 years old will not be taxed, assuming the account has been open for at least five years. In certain circumstances, taxpayers can also make penalty-free withdrawals before they retire.
Whether this account would be better than a traditional tax-deductible IRA depends on your individual circumstances--primarily whether you believe you’ll be in a higher or lower tax bracket at retirement than you are today. If you believe you’ll drop a tax bracket or two at retirement, the traditional IRA may be better for you. If your bracket is likely to remain the same or higher, the Roth may be a better choice.
Here are some readers’ questions and some answers about Roth IRAs.
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Q: I understand there are income restrictions on Roth IRAs.
A: The restrictions vary based on your marital status and on whether you are opening a Roth IRA with your first $2,000 contribution or whether you are rolling retirement funds over from a traditional IRA.
That said:
* You may not roll an existing IRA into a Roth IRA if you earn more than $100,000. That income level applies whether you are married or single.
* You may start a Roth IRA by contributing up to $2,000 per year per person if your income is below $95,000 if single or $150,000 if married and filing jointly. The amount you are allowed to contribute drops if your income exceeds these thresholds and expires completely if your adjusted gross income is more than $110,000 if single and $160,000 if married and filing jointly.
* You may not contribute to a Roth IRA if you are married and filing separately.
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Q: May I make a $2,000 nondeductible contribution to a traditional IRA as well as a $2,000 contribution to a Roth IRA?
A: Technically, you can contribute to both. However, the contribution maximum is aggregated. So the most you can contribute to either or both accounts is $2,000 annually.
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Q: Under what circumstances may I withdraw money from a Roth IRA before retirement?
A: Penalty- and tax-free withdrawals are allowed from accounts that have been open for at least five years and are either made after age 59 1/2; on death or disability; or for a qualified first-time home purchase (subject to a $10,000 lifetime limit) for the taxpayer or a spouse, child or grandchild.
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Q: I make nondeductible IRA contributions now. Will I be taxed again when I withdraw the money?
A: With traditional nondeductible IRA contributions, only the interest is taxable. The principal, on which you have already paid tax, is withdrawn tax-free.
Figuring the taxable and nontaxable portions of the withdrawals is not difficult. You simply determine which portion of your total IRA holdings are pretax and which are after-tax. That ratio is applied to the withdrawal. The process is repeated for all subsequent withdrawals.
If you are withdrawing the money to roll it over into a Roth IRA, all the interest accumulations are taxable. However, you may divide the tax into four equal annual payments that you’ll send in with your next four annual tax returns.
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Q: Over the last several years, I have contributed $2,000 on a non-tax-deductible basis to an IRA. I would like to open a Roth IRA. May I transfer a nondeductible IRA to the Roth as well?
A: Yes, as long as you meet the income and filing restrictions detailed in the first answer.
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Q: I have a 401(k) account with about $9,000, and I will soon be leaving my employer and rolling the money over into an IRA. I am returning to graduate school this fall and would like to tap into this account to pay for some of my education. Does the new tax law permit this?
A: Yes. But be certain that you roll your 401(k) over into a traditional IRA account, not a Roth IRA. The Roth IRA does not allow for penalty-free education withdrawals, whereas the traditional IRA will after Jan. 1. However, you must still pay ordinary income taxes on the withdrawal. You should be aware that there are other tax breaks available for people who are paying for higher education. You may want to consult a tax advisor.
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Q: I am 67 and my wife is 63. We operate our own small business. We would like to roll our IRA accounts over into Roth IRAs. But I worry that I won’t be able to do this because in five years--the minimum amount of time a Roth IRA must be held before withdrawals are made--I will be 72 and will already have to have made my first mandatory withdrawal. Is this true?
A: The reason the government requires distributions from the traditional IRA and 401(k) tax-deferred retirement savings accounts at age 70 1/2 is that it wants you to pay taxes on the money to fund the government’s operations. No withdrawals, no taxes. Because distributions from Roth IRAs are tax-free, there is no mandatory distribution age. You may take a distribution any time after holding the account for five years.
