Because of all of the mystery, intrigue, and curiosity regarding the Roth IRA, we herewith present the 10 questions that seem to be causing the most confusion and generating the greatest number of posts (not to mention excitement!) on our discussion boards. Here they are:
I have a company pension plan and contribute as much as I can to a 401(k) plan. Can I still make a full annual contribution to a Roth IRA?
You sure can, as long as your adjusted gross income (AGI) doesn't exceed the limits allowed for a Roth contribution for the year. Your participation in an employer-sponsored retirement plan has no effect on your ability to contribute to a Roth IRA. Therefore, if your AGI is less than $95, 000 (single filer) or $150,000 (joint filer), you may make a full contribution to a Roth IRA.
I converted my traditional IRA to a Roth IRA back in January. I've just discovered that my adjusted gross income will exceed the $100,000 conversion limitation this year. What should I do?
You are allowed to "recharacterize" your Roth IRA conversion back to a traditional IRA without any penalty or tax. You are simply required to make this recharacterization prior to October 15 of the year following the year of the conversion. You must "un-convert" not only your original conversion amount, but also any of the earnings generated by that original conversion. So, just because you go over the AGI limitation, all is not lost. Contact your broker and he should be able to help you with the recharacterization back to a traditional IRA account.
My daughter is 16 years old. Can she make a Roth IRA contribution?
Age is not a determining factor. As long as you have earned compensation with which to open the Roth IRA account, and as long as you are under the AGI limitations, you may make an IRA contribution regardless of your age.
My father is 73 years old. Can he convert his traditional IRA to a Roth IRA?
Again, as noted above, age is not a determining factor. If your dad's AGI is under the $100,000 limitation, he is eligible to make the conversion. Be aware, though, that your father has begun minimum required distributions (MRD) from his traditional IRA. Therefore, before he converts that traditional IRA to a Roth, he must receive his MRD for that year. Whatever that amount is, it cannot be transferred to the Roth.
I'm retired and drawing Social Security. Can I contribute part of my Social Security benefits to a Roth IRA account?
Nope. Sorry. In order to make a Roth IRA contribution, you must have earned compensation. Earned compensation is generally income that you receive through work as payment for your labor in one form or another. It's reported to you on a W-2 form, or you file Schedule C (Business Income) with your normal tax return. Earned compensation generally does not include Social Security benefits, pensions, interest, dividends, rental income, or capital gains.
I intend to retire at age 50. When I do, I'll need income. Can I take money from my Roth IRA without paying any taxes or penalties?
Potentially, yes. Under the IRS ordering rules, you are allowed to remove your original contributions at any time without tax or penalty. In addition, after you have waited at least five tax years, you are able to withdraw your original conversion amounts without taxes or penalties. It's only when you get to the earnings generated by the original contributions and conversions that you will have a tax and/or penalty problem.
And, even if you DO determine that you'll have to break into the earnings prior to age 59 1/2, you may still avoid the penalty (but not necessarily the tax). If you remove the funds from your Roth IRA account using a distribution method that is part of a scheduled series of substantially equal periodic payments made over your life expectancy (or the joint life expectancy of you and your beneficiary), you may still be penalty-free.
For income tax purposes, how do I report a conversion and/or an annual contribution to or a withdrawal from a Roth IRA?
Annual contributions to a Roth IRA are not reported on your federal income tax return. Conversions of a traditional IRA to or withdrawals from a Roth IRA during the tax-year are reported on Form 8606. The form and its instructions may be obtained from the Internal Revenue Service online.
If I convert my traditional IRA to a Roth IRA, will that conversion income increase my AGI for the current year?
Absolutely. Conversion income will impact any and all tax issues that are based upon AGI... except for any current or future Roth contribution and/or conversion issues. But your medical expenses (7.5% AGI floor), miscellaneous deductions (2% AGI floor), taxability of Social Security (based upon AGI), passive loss limitations (based upon AGI), and many other tax provisions that use AGI as a guidepost will be affected -- in some cases, severely. So this must all be taken into consideration when you decide to make a Roth conversion.
If I have a large tax balance due next April because of my Roth IRA conversion, will I be able to avoid the underpayment penalties?
No. There is no exception to the underpayment penalty just because the balance due was caused by a Roth IRA conversion. There are other exceptions to the underpayment penalty that you might want to review that may allow you to "dodge" the penalty, but there is no "safe harbor" simply because the underpayment was caused by a Roth IRA conversion.
Should I convert my traditional IRA to a Roth IRA?
That is a difficult question to answer. The conversion question is so personal that each and every individual must really look at the issues, understand the tax pros and cons, and realize that there are other "non-tax" and even "non-financial" reasons to convert or not to convert. So that will require some additional reading and study on your behalf.
In addition, the conversion decision rests on a number of factors such as tax rates today versus those of tomorrow, how you would pay taxes due on the conversion, how long the money can stay in the converted account, and the size of your estate.
And finally, since we are Fools, and we're all about giving, here is your free, bonus Q&A:
I've heard from a friend that the Roth IRA AGI limitation is $100,000. I've heard from other friends that the actual AGI limitation is much greater. Which is it?
It depends if you are talking about a "conversion" or "contribution."
If you are talking about converting your traditional IRA to a Roth IRA, then the AGI limitation is $100,000 for all filing categories (except for married-separate, which is effectively prohibited from making a conversion regardless of the size of AGI, unless the couple is separated and has lived apart for the entire tax year).
But if you are talking about making a contribution, then the rules are a bit different. The AGI limitations are different based upon your filing status. They are as follows:
Single and Head of Household Filers
- Income: AGI = $95,000 or less.
- Rule: A full annual contribution to a Roth IRA is allowed 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.
Joint Filers
- Income: AGI = $150,000 or less.
- Rule: A full annual contribution to a Roth IRA is allowed 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.
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.
