Subsequent upon implementation of Taxpayer Relief Act 1998, Roth IRA was introduced with effect from 01 January 1998. Nomenclature has been derived from the name of William V Roth Jr., a late Senator. Roth IRA does not provide deduction for contributions made towards retirement savings but offer a unique benefit of tax relief on all earnings, which is not provided by any other retirement savings plan. However to obtain this benefit you must fulfill certain criteria. It also offers you penalty free early withdrawals (of course not on all withdrawals) and eliminates your obligation to avail laid down minimum distributions after you attain the age of 70-1/2 years. This facilitates you in growing your money that too tax-free.

You have the option to participate in Roth IRA in two ways; one by establishing Roth IRA through regular contributions and other by conversion of your traditional IRA-to which you are contributing- to a Roth IRA. You can contribute towards Roth IRA even when you are participant of retirement plan that is offered by your employer. You can contribute towards Roth IRA up-to $4,000 during 2006, if you have alimony or compensation income equal to contributed amount and your gross income after modification does not exceed laid down limits.

The maximum limits of contribution towards Roth IRA are $95,000 and $150,000 for individuals and married couples who fill joint returns, respectively. Whenever your gross income –modified and adjusted- exceeds laid down limits of $110,000 for individual and $160,000 for married couples, your contribution amount is eliminated totally. This is achieved by reducing your contributions gradually.

If you convert your traditional IRA to a Roth IRA you will have to pay taxes during the year of conversion. These taxes are worth paying when you consider long-term saving benefits you are going to get by converting your IRA to a Roth IRA. Like other Individual Retirement Arrangements (IRAs) Roth IRA also allow individuals, especially tax-payers who fulfill laid down criterion of income limits, to make tax-free contributions made to Roth IRAs as these contributions are basically made from post-tax money savings towards their retirement plans. You get all tax benefits applicable to Roth IRA whenever you make withdrawal from Roth IRA. Normally, withdrawals from IRAs are not taxed subject to certain rules. This aspect makes Roth IRA different from other traditional IRAs. It is considered as best way of converting your gross investment income into a non-taxable income. You do not get tax deduction on.

Conversion of traditional IRA to a Roth IRA

For any conversion from retirement plan to IRA or traditional IRA to a Roth IRA there are laid down criteria. The main aim of any conversion or roll over is to acquire maximum financial benefits. You have to examine the following factors to determine whether you are eligible for conversion of your traditional IRA to a Roth IRA or not.

Qualifying and Non-Qualifying factors

• You are not eligible for Roth IRA conversion if you are married staying with your spouse still filing returns separately. You have to live separated from your spouse for the entire year if you are filing return separately and want to convert to a Roth IRA.
• You can not roll over your normal IRA to a Roth IRA if your modified gross income is more that $100,000.
• If your traditional IRA is inherited by you from an individual except your spouse, you are not allowed to convert such IRA to a Roth IRA.
• Even if you have exercised roll over option for your traditional IRA during period of last 12 months, you can convert such rolled over IRA to a Roth IRA.
• You have the option to roll over portion of your present IRA to a Roth IRA if you fulfill other conditions. However, while rolling over portion of IRA you are not allowed to roll over a portion that is non-taxable

Roll over and Conversion

Remember you can only roll over an IRA to a Roth IRA. IRAs which can be rolled over to a Roth IRA are traditional IRAs, other Roth IRAs and SEP IRAs. You cannot roll over your 401k plan account or any other retirement plan offered by company to a Roth IRA. However you can roll over your retirement plan distributions to a Roth IRA step-by-step. Firstly you have to roll over your distributions to a traditional IRA and then convert this IRA to a Roth IRA.

Roth IRA Distributions

All distributions from a Roth IRA are exempted from taxes till you withdraw your all regular contributions. Afterwards you will withdraw converted contributions. After you withdraw your regular and converted contributions further withdrawals will be from your earnings. These withdrawals are exempted from taxes provided you have contributed towards Roth IRA for a minimum period of five years and your age is more than 59-1/2 years. Otherwise, barring few exceptions, these withdrawals are subject to 10% penalty tax and other taxes.

Distributions from the Roth IRA are to be withdrawn in the following sequence.

• Annual contributions made by you to Roth IRA. Rolled over contributions are not included in this category.
• If you have rolled over or converted contribution they are to be withdrawn next, specifically the portion of conversion which is taxable.
• You can withdraw non-taxable portion afterwards.
• In each withdrawal taxable portion is to be withdrawn first and then the non-taxable portion.
• Finally you can withdraw earnings which come from increase of value within the Roth IRA.

Restrictions on Roth IRA Transactions

Like other traditional IRAs, Roth IRA has also certain restriction regarding transactions. Usually, following restrictions are associated with the Roth IRA.

• You are not allowed to borrow any amount from your IRA and also you can not acquire a loan by producing Roth IRA amounts as security.

• Purchasing property from Roth IRA and selling your property to Roth IRA is prohibited.

• You can not buy a personal property against your Roth IRA balances until these funds are distributed to you

• You can not invest your Roth IRA balances in collectible funds.

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Category: 401k Plans

Tags: 401k plan, Roth IRA.