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How Many Roth IRAs Do You Need?

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By Roy Lewis

How many Roth IRAs do you need? Seem like a stupid question? In a way, it is. Regardless of how many physical Roth IRA accounts you have, Uncle Sammy really treats all of them as "one big" Roth IRA account.

"But wait," you might be saying to yourself, "I remember that the IRS required different Roth IRA accounts for different purposes. I even remember that my broker made me open a separate Roth IRA account for my conversion, and a brand new one for my contribution."

That very well may be true. When Roth IRA accounts first came on the scene in 1998, the IRS (because of the law at that time) suggested that different Roth IRA accounts be established for different transaction types -- one for conversions, one for contributions in a certain year, another for contributions in another year.

Why? Because the "holding period" rules were different for each type of Roth IRA transaction. And, as you should know, the holding period rules are very important when it comes to determining if your Roth IRA earnings can be withdrawn tax-free.

(Note: If you're not familiar with the holding period rules for the Roth IRA, you really should be. For additional information on how the Roth IRA tax rules work, see Roth IRA - Part III.)

Things were so confusing that the IRS even advised brokers and mutual fund companies to "strongly recommend" that their clients open different Roth IRA accounts for different types of transactions. Which they did. People were making conversions, recharacterizations, reconversions, and contributions left and right. And, the holding period rules (as they were written) were becoming a very bad dream.

It was about that time that the folks at the IRS had an epiphany: The holding period rules are impossible to understand and/or enforce... so we'll make 'em easier to deal with. So, the current holding period rules were put into effect.

It took awhile for the word to get to many brokers and mutual fund companies, but they finally got on board and began to provide the appropriate information to their clients. And now, for all intents and purposes, you really have only one Roth IRA holding period for your contributions, but any conversions have their own separate individual holding period dates.

Even after all of this, the question begs an answer: While you don't need more than one, should you want more than one Roth IRA account? The answer, depending on your situation, might very well be a resounding "YES!"

Before we get into why you might want multiple Roth IRA accounts, let's look at the reasons why you might want only one:

IRS Requirements: Uncle Sammy has said that you are only required to have one Roth IRA account. And, even if you have more than one, he'll treat them all as one. So, why do more than what you're legally required to do, eh?

Reduce Fees: As you already know, the more accounts you have, the more you'll pay in service fees and charges.

Simplicity: The fewer accounts you have, the easier it is to keep track of them all.

Administration: The fewer records you're required to maintain, the easier it'll be to manage your Roth IRA portfolio.

So, given all of the above, why would you ever want more than one Roth IRA account? Well... let's think for a second. There could be quite a few reasons. Some of the major reasons would include:

Portfolio Diversification: If you invest in various stock, bond, and mutual funds, you may need a separate account for each type of investment. This isn't usually the case, but if you use "Broker X" for your stock portfolio, you might have difficulty buying "Mutual Fund Z" from that broker -- necessitating a separate account with either a mutual fund company or a more mutual-fund-friendly broker.

Conversions Made in 1998: For 1998 only, you were allowed to spread the taxable income from your conversion (traditional IRA to Roth IRA) over a 4-year period. If you withdraw some of those converted funds within that 4-year period, you are required to accelerate some of that income. If you commingle a 1998 Roth IRA conversion account with other conversions (1999 or later), or regular Roth IRA contributions, and then remove some of those 1998 converted funds, you might have a computation nightmare on your hands determining your reportable accelerated income.

Tracking Distributions: As you can read in the section "IRS Ordering Rules" in Roth IRA - Part V, there is a required IRS method for taking distributions. Simply put, distributions are deemed to come from contributions first, then from converted funds, then from earnings. Therefore, having separate contribution and conversion Roth IRA accounts could make practical sense, so they can be easily tracked.

Recharacterizations and Reconversions: You might find that you want (or need) to "undo" or "reverse" (commonly called a recharacterization) a Roth IRA conversion and/or contribution and move those funds back to a traditional IRA account. If your broker will not allow you to simply reclassify the Roth IRA back to a traditional IRA account, you might have to open a number of ancillary IRAs (both traditional and Roth) to accomplish the recharacterization and/or reconversion. These accounts might only really be open for a few days... or perhaps even a few hours. Keeping an "extra" account open might make your life just a bit easier.

Beneficiaries: To plan for estate tax issues, you might not want your "one big" Roth IRA going to only one of your beneficiaries. Or, even if you name more than one beneficiary for your "one big" IRA, you might not want them all to receive an equal share of the money. You might want to be a bit more creative and plan for different amounts to go to each beneficiary. There are a number of ways to handle this -- especially with a good estate plan -- but maintaining multiple Roth IRA accounts might also do the trick. Each Roth IRA account could have a separate beneficiary who will receive only the funds in that specific Roth IRA account.

Overfunding: As you know, you're allowed to make a Roth IRA contribution early in the year. As you also know, if your AGI exceeds certain limits, you are not allowed to make a Roth IRA contribution and will be required to remove any contribution placed into the Roth IRA account during the year and the earnings on those contributions. While the IRS has provided guidelines on how to compute the earnings on your Roth IRA account, it's not necessarily an easy computation. And, in some cases, when the Roth IRA has contribution, conversion, and earnings, the IRS-approved computations might not give you the real income (or loss) impact of that overfunded contribution.

But, creating a new Roth IRA account to "hold" this contribution until you are certain that it will be allowed might save you many sleepless nights. And the $10 (or even $20 or $30) annual fee for this account might end up being a very cheap insurance policy compared to the pencils you break trying to separate and compute your "earnings" on this specific Roth IRA contribution in your "one big" Roth IRA.

So, you only need one Roth IRA account, but you could find that you want more than one Roth IRA account. Just like during Thanksgiving dinner -- when you decided that you wanted that second helping of dessert, even though you really didn't need it -- it might cost you a few pounds in the long run, but it was very satisfying for the short term. And the decision to have one or multiple Roth IRA accounts, as with the dessert, is entirely yours.

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