Is it time to start a Roth IRA?
If you already have significant pre-tax retirement savings, opening a Roth IRA can be a smart move.
Why does the Roth individual retirement account (IRA) generate so much buzz? Start with this: While no one knows what taxes will be like in the future, a Roth IRA can help you manage the risk that taxes could be higher when you're retired.
Roth IRA benefits essentials
A Roth IRA doesn't reduce your taxable income the way contributions to your employer's retirement plan do or a traditional IRA may. But like those accounts, it will defer any investment growth from annual taxes—potentially leaving you with more money to reinvest for your future.
Roth IRAs also allow you to make tax-free withdrawals of both your principal and earnings, as long as the account has been open for five years and you meet either of the following criteria:
- You are 59-1/2 or older.
- You withdraw $10,000 or less from the Roth IRA to purchase your first home.
Generally, withdrawals also are tax-free in the event of death or disability. Those are important differences from withdrawals of pre-tax contributions from your employer's retirement plan, which are taxed as income.
Can you contribute?
The IRS imposes limits on who can qualify to contribute to a Roth IRA. For 2012, those limits are:
|Modified Adjusted Gross Income (MAGI)**||Eligible to contribute?||Contribution limit*|
|Less than $107,000||Yes||$5,000 annually|
|At least $107,000 but
less than $122,000
|Yes||Less than $5,000**|
|$122,000 and over||No||N/A|
|Married filing jointly|
|Less than $169,000||Yes||$5,000 annually|
|At least $169,000 but
less than $179,000
|Yes||Less than $5,000**|
|$179,000 and over||No||N/A|
*Individuals age 50 and older may be allowed to make additional "catch-up" contributions of up to $1,000.
**In this MAGI range, contribution limits are reduced on a sliding scale per IRS guidelines and dollar limits are for the 2012 calendar year.
Other reasons to consider a Roth IRA.
- You can convert traditional IRAs and qualified employer retirement plan account (subject to the plan's provisions*) balances to a Roth IRA. If the benefits of a Roth IRA sound good to you but your retirement funds are held in a different type of account, you may be able to move the funds, no matter what your income. Although you will have to pay tax upfront on some or the entire amount you convert, your money will be tax-free as long as you meet the withdrawal criteria mentioned above.
- A Roth can give you more flexibility in retirement. Because Roth withdrawals are generally tax-free, they help keep your tax bill lower in retirement. That can make a Roth IRA an attractive savings vehicle, since qualified distributions would not be recognized as income.
- Roth IRAs have estate-planning benefits. You can keep contributing after age 70-1/2 — the cutoff for a traditional IRA — and you don't have to take required minimum distributions. What's more, your heirs won't pay taxes on withdrawals from a Roth IRA that you leave to them.
Fast Fact: Individual retirement accounts were introduced in 1974 with the enactment of the Employee Retirement Income Security Act (ERISA), according to the Congressional Budget Office.
Thinking about converting a traditional IRA to a Roth IRA?