It seemed like such an easy concept when it was first introduced back in 1997: Put some money away for a while and then take those funds and earnings out tax-free at some time in the future. But, like most tax issues, the Roth IRA has turned into a monster. And while the concept may still remain an easy one to understand, the actual rules and regulations have become very complex. In the next few articles we'll review the Roth IRA in greater detail and try to make things clear. Let's get started.
An individual may make an annual nondeductible contribution to a Roth IRA that may not exceed the smaller of the maximum allowable annual IRA contribution or 100% of the individual's earned income for that year, minus the total of all contributions for that tax-year to all other individual retirement plans (other than Education IRAs) owned by that person.
What this means is that your total contributions for the tax-year to a traditional IRA and a Roth IRA may not exceed the total contribution allowed for that year. So, in effect, you'll want to determine which savings vehicle is best for you (Roth or traditional IRA), and place your allowable contribution in the appropriate IRA. While the law certainly doesn't prohibit you from placing, for example, $500 in a Roth IRA and $1,500 in a traditional IRA, the administrative hassles and fees of this type of arrangement are not negligible. But because of the Roth IRA phase-out rules (that we'll discuss below), "splitting" your allowable IRA contribution into a traditional IRA and a Roth IRA may be your only option if you want to make a full contribution for that year.
A couple of distinctions to note:
- Be aware that you may contribute to a Roth IRA and a SEP, SIMPLE, and/or Education IRA at the same time. The annual contribution limit on IRAs is only applicable to the combination of traditional and Roth IRAs. So if you are in a situation where you are able to fully fund a Roth IRA and a SEP, SIMPLE, and/or Education IRA, the law allows you to do so.
- Remember also that you may contribute to a Roth IRA even if you are covered by a company retirement (pension/401(k)/profit sharing) plan.
John is a single taxpayer. In 2001 he will make $50,000 in earned income. John is also a participant in his company's pension plan. Additionally, John will contribute the maximum amount to his employer's 401(k) plan. In his spare time, John has a consulting job and will earn additional business (Schedule C) income in the amount of $15,000. John will make a maximum SEP IRA contribution based upon his net business income. John also makes an Education IRA contribution for the benefit of his daughter. Even with all of these tax-deferred savings and investment vehicles, John can still make a $2,000 Roth IRA contribution for 2001.
It should also be noted that any amounts converted to a Roth IRA (which we'll discuss next) in a "qualified rollover contribution" are not counted toward the maximum annual contribution limit. So in the example above, even with everything John had going on, he could make a "qualified rollover contribution" and still have the choice of making a $2,000 Roth IRA contribution for 2001.
And now for the bad news -- some individuals may not be eligible for the Roth IRA. Limitations based on your tax filing status and adjusted gross income (AGI) are listed below:
Single and Head of Household Filers
- Income: AGI = $95,000 or less.
- Rule: The maximum annual contribution to a Roth IRA is allowable (assuming that the earned compensation rules are met).
When AGI rises above $110,000, no Roth IRA contribution is allowable. Between the $95,000 and $110,000 phase-out range, only a partial Roth IRA contribution will be allowed. (For details on computing allowable IRA contributions in the phase-out range, see IRS Publication 590, Individual Retirement Arrangements.)
- Income: AGI = $150,000 or less.
- Rule: The maximum annual contribution to a Roth IRA for each of the joint filers is fully allowable (again, assuming that the earned compensation rules are met).
When AGI rises above $160,000, no Roth IRA contribution is allowable. Between the $150,000 and $160,000 phase-out range, only a partial Roth IRA contribution will be allowed. (For details on computing allowable IRA contributions in the phase-out range, see IRS Publication 590, Individual Retirement Arrangements.)
Married Filing Separately
For married persons filing separate returns, the AGI limitation is so severe as to virtually prohibit a Roth IRA contribution. For married/separate filers, the "phase-out" range is between $0 and $10,000. This means that a married/separate filer will never be able to take a full Roth IRA contribution, and when AGI rises above $10,000, no Roth IRA contribution will be allowed whatsoever.
What the Heck is a Phase-Out Range?
If you fall into the phase-out ranges listed above, your Roth IRA contribution is limited on a pro-rata basis, depending on how far your AGI moves into the phase-out range.
Jill -- a single person -- has an AGI of $105,000, has earned income of at least $2,000, and is not a participant in her employer's pension/profit sharing plan. Since Jill is two-thirds into the phase-out range, she is only allowed a one-third contribution to her Roth IRA. Therefore, her maximum Roth IRA contribution for 2001 would amount to $666.67 (which she can round up to $670). Since her Roth IRA was limited, can she make a traditional IRA contribution? Sure... in the amount of $1,330. Will that IRA contribution be deductible? That will depend on Jill's circumstances. In our example, Jill isn't a participant in her employer's pension/profit sharing plan, so her traditional IRA would be fully deductible. If she were a participant in her employer's pension plan, her deductible IRA contribution would be limited as discussed here.
You should be aware that there are no age limits on contributions to a Roth IRA. A young child with earned income can make a Roth IRA contribution if it is deemed appropriate. Also, unlike a regular IRA, persons over the age of 70 1/2 can still make Roth IRA contributions as long as they have earned income and are not otherwise restricted by the AGI limitations. And, unlike a regular IRA, a Roth IRA is not subject to the "required minimum distribution" rules that require minimum IRA distributions when you turn age 70 1/2.
Remember that Roth IRA contributions for a tax-year must be made no later than the due date of your tax return, not including extensions. So if you are qualified to make a 2001 Roth IRA contribution, that contribution must be made no later than April 15, 2002, the due date of your tax return.
Next we'll continue to look at the Roth IRA and tackle a subject dear to the Beatles and Beethoven: rolling over.