What Do Roth IRAs
Offer?
Traditional IRAs have long
been popular with investors. For many people, they offer a substantial current
income tax deduction. And the assets in an IRA grow tax deferred.
Unfortunately, there are
some significant eligibility restrictions for traditional deductible IRAs. If
you’re an active participant in a qualified retirement plan — such as a
simplified employee pension plan or a 401(k) plan — your IRA deduction could
be reduced or eliminated if your income is above certain levels.
Roth IRAs
Now Congress has stepped
in to help fill the gap.
A tax-favored vehicle
called the Roth IRA offers tax-free accumulation and withdrawals if certain
conditions are met.
Unlike traditional
deductible IRAs, taxpayers cannot deduct contributions made to Roth IRAs.
However, unlike the case with traditional IRAs, qualified distributions from
Roth IRAs aren’t included in a taxpayer’s gross income or subject to the
additional 10 percent federal income tax penalty for early withdrawals.
This means that qualified
withdrawals from a Roth IRA will be free of federal income tax.
Qualifying
Distributions
To qualify for a tax-free
withdrawal at retirement (after age 591/2),
a distribution must be made after a five-year holding period. In other words,
you cannot make a withdrawal until five years from the first tax year you make a
contribution to your Roth IRA.
After this initial holding
period, you may also make withdrawals due to death or disability, or to purchase
your first home (up to a $10,000 lifetime cap), without triggering federal
income taxes or being subject to the 10 percent federal income tax penalty for
early withdrawals.
You may also withdraw
funds from your Roth IRA for college expenses (after the initial five-year
holding period) without incurring the 10 percent penalty, although regular
income taxes would be due on withdrawn earnings.
Keep in mind that although
qualified distributions are free of federal income taxes, state and/or local
taxes may apply in some states.
Limits
For tax years 2002 to
2004, the Roth IRA contribution limit is $3,000, and it will gradually reach
$5,000 in 2008.
Eligibility to contribute
to a Roth IRA phases out for taxpayers with higher incomes. Eligibility begins
phasing out for single filers with adjusted gross income of $95,000, phasing out
completely when adjusted gross income reaches $110,000. Similarly, eligibility
begins phasing out for married taxpayers (filing jointly) with adjusted gross
income of $150,000, phasing out completely when adjusted gross income reaches
$160,000.
"Catch-Up"
Contributions
Special
"catch-up" contribution provisions enable those nearing retirement to
save at an accelerated rate. Those aged 50 and older before the end of the
taxable year will be eligible to contribute more than the regular limits.
Eligible Roth IRA participants may contribute an additional $500 per year from
2002 through 2005, and an additional $1,000 per year thereafter. This is in
addition to the otherwise maximum contribution limit (before application of
adjusted gross income phaseout limits).
Unlike a traditional IRA,
there are no penalties if you make contributions to (or fail to take minimum
distributions from) a Roth IRA after you reach age 701/2.
If you’re looking for a
retirement savings vehicle with some distinct tax advantages, the Roth IRA could
be right for you.
© 2003 Emerald Publications
