Roth IRA Rules and Guidelines
Roth IRA Basics
If you are in the process of saving for retirement, you've probably heard of Roth IRAs by now, or at the very least traditional IRAs. So what is a Roth IRA?
In this lens, we'll give you a basic understanding of traditional and Roth IRAs, including what they are, how much you can contribute, when you can take withdrawals, the differences between the two and much more.
2011 Roth IRA Deadline
The deadline to contribute to a Roth IRA for 2011 is April 17, 2012.
You can contribute up to $5,000 to a Roth IRA in 2011; if you are age 50 or over you are allowed to make an additional "catch up" contribution of $1,000 for a total of $6,000.
The Roth IRA contribution limits are the same for 2012.
What is a Roth IRA?
Perhaps the most significant change was the creation of the Roth IRA in 1997 as part of the Taxpayer Relief Act. So what is a Roth IRA? Named after its main legislative sponsor, Senator William Roth of Delaware, the main difference between a Roth IRA from other tax advantaged retirement plans is that the tax break is at the withdrawal level instead of the contribution level. With traditional IRAs you get the tax break up front in the form of a tax deduction; with Roth IRAs you get the tax break at the back end, as qualified withdrawals are tax-free.
Roth IRAs are a great tool for people saving not only for retirement but for college, buying your first house, and other goals. Here are some of the advantages that Roth IRAs have over other retirement accounts:
* Earnings from contributions or converted funds grow tax-free, and may be taken out tax and penalty free once the taxpayer reaches age 59 Â½, or if other qualifying events take place.
* Contributions to a Roth IRA can be withdrawn tax free at any time, for any reason.
* Funds that were converted from a traditional IRA can be withdrawn tax free after five years.
Roth IRA Checkup: 10 Things You Should Do Before Year End
It’s hard to believe it’s almost the end of 2010. It seems like we just celebrated the 4th of July and here we are going into the Christmas season. While shopping and spending time with family are probably at the top of your to-do list for the next month, you should make time for some year end financial planning as well. Just like some tax planning strategies must be done at year end (to ensure you’ll get the benefit in the current year), some IRA strategies need to be implemented at year end as well.
As pensions become extinct, 401K matches shrink, and the future of Social Security becomes more and more uncertain, your IRA and Roth IRA balances become even more important. You should treat them with care, which means monitoring them on a regular basis to make sure they’re still working for you. This is especially important to do at the end of each year, to see if any strategies need to be implemented before the new year begins.
Here are 10 things you need to review your IRAs and Roth IRAs for before 2011 gets here:
What is the Roth IRA Contribution Limit for 2010?
The contribution limits for traditional and Roth IRAs are indexed each year for inflation. However, since we have had little to no inflation for the last couple of years, the contribution limits have remained unchanged since 2008.
Nevertheless, here are the Roth IRA contribution limits for 2010:
Under 50 Years of Age: For people who are under age 50, the maximum contribution you can make to a Roth IRA is $5,000. If your taxable compensation for 2010 is less than $5,000 then your Roth IRA contribution is limited to your taxable compensation.
Age 50 or Older: If you are age 50 or older you can make a catch-up contribution in addition to the $5,000 limit. The catch-up contribution is $1,000 bringing the maximum contribution up to $6,000. Again, you must have taxable compensation to contribute to a Roth IRA, and your contribution is limited if your taxable compensation is below the $6,000 contribution limit.
401K vs Roth - Which is Better?
The Roth IRA vs 401K Debate
There are many factors to consider when determining whether to invest in a 401k vs a Roth IRA. Both retirement plans have benefits to offer. If your budget allows, it is best to invest in both a 401k through your employer and a Roth IRA on your own. However, that is not financially feasible for many people, so you may find yourself wondering whether one is better than the other.
A Quick Primer on the 401K
Most people are familiar with 401K plans, a retirement plan offered by many employers. With a 401K, you get to elect a percentage of your salary to save and invest, and that part of your salary goes into your 401k before it is taxed, which helps reduce the taxes you pay on your income tax return.
Historically, companies have often matched the amount you save for retirement. For example, if you invested four percent of your salary into your 401k, your company might also contribute four percent on your behalf. Financial planners often refer to the company match as "free money" because it is compensation that your employer is providing above and beyond your regular salary.
Continue reading 401K vs Roth IRA...
Should You Do a Roth IRA Conversion in 2010?
As we near the end of 2010, many people have already done Roth IRA conversions, and many are wondering if a Roth IRA conversion in 2010 is the right move for them.
Why so much focus on Roth IRAs this year? It’s simple. The rules that determine who can convert a traditional IRA to a Roth IRA have been changed to allow more people to convert to Roth IRAs. Before 2010, only people with modified adjusted gross incomes of less than $100,000 could convert. Starting in 2010, this income limitation has been lifted, meaning most people are eligible to convert their traditional IRAs to Roth IRAs.
In addition to the income limitation being lifted, the IRS is allowing taxpayers who do a Roth IRA conversion in 2010 to spread their taxes out over two years. So instead of paying it all on your 2010 tax return, you can pay half in 2011 and half in 2012.
Roth IRAs for Kids
As I’ve mentioned before, Roth IRAs are my favorite type of investment account because of the many tax advantages.
But did you know you could setup a Roth IRA for a child? What a great way to teach a child about money and saving than to setup a Roth for them. And the tax-free compounding… imagine how much your child could have saved by time they go to college or buy their first home or are ready to retire if you help them start saving while they are still young.
Of course there are rules. First, you must have earned income to contribute to a Roth IRA. Surprisingly, there is no age minimum, so anyone can start a Roth IRA at any age, as long as they have taxable compensation.
Many teenagers work, so any money earned from their job - even if it’s from mowing lawns or babysitting - can be used towards the “taxable compensation” rule. [A gray area is whether you can pay your child to do household chores and use those “earnings” to meet the taxable compensation rule. There are no clear guidelines regarding household chores and taxable compensation, but beware that the IRS could challenge your position if you choose to go this route.]
A great tax planning strategy if you own your own business is to hire your child to do work in your business and use his or her earnings to contribute to a Roth for them. Not only does this meet the “taxable compensation” rule, allowing you to start a Roth for your child, but it’s a great way to shift income from your higher tax bracket to your child’s lower tax bracket.
Of course, getting your child to give up their hard earned money to put into a Roth IRA may prove to be difficult. No worries, the money used to fund the Roth IRA does not have to come from the child’s earnings. Anyone can contribute to a Roth IRA for a child, as long as the child has earned income.
While most investment companies have minimums you must meet to open an account, many offer “minor accounts” for children under age 18.
The 2011 Roth IRA contribution limit is $5,000 ($6,000 for people age 50 or over). You have until April 17, 2012 to make contributions for 2011.