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Newsletter |
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To Roth or Not
To Roth? That is the IRA Question!
For many taxpayers, the Roth IRA is one of the best tax-advantaged
retirement plans around. Are you eligible to harvest the grapes of Roth?
Is a Roth IRA or a traditional IRA right for you?
Choosing between the Roth IRA and a traditional IRA can be difficult,
and it's a big decision. The Roth IRA is a relatively new retirement
vehicle, first available in 1998. Not all taxpayers can get full benefit
from a Roth IRA, because of rules called "income phaseout limitations."
For single taxpayers, the Roth benefit is limited if adjusted gross
income exceeds $95,000. . . for joint filers, limitation begins at
$150,000. Married persons filing separately begin losing the benefit
with the first dollar of income. In each case, a phaseout range allows a
reduced benefit until income reaches a maximum amount. By contrast,
regular IRA contributions are not subject to gross income limitations
unless the taxpayer or the taxpayer’s spouse is a participant in an
employer sponsored plan.
If you're single and your adjusted gross income exceeds $110,000, you
cannot contribute to a Roth IRA. You could, of course, contribute to a
traditional IRA. On the other hand, if you're a single filer and your
income falls below the $95,000 adjusted gross income limit, you can make
the full maximum annual $4,000 contribution to a Roth IRA. A special
"catch-up" contribution of $500 can be added to that limit if you've
passed your 50th birthday. If your income falls somewhere between this
$95,000 - $110,000 range, as a single taxpayer you are eligible to make
a partial Roth IRA contribution. The same logic applies to joint filers,
subject to the $150,000 - $160,000 phaseout limitations.
Contributions to a Roth IRA are never deductible. However, all the money
in a Roth IRA account may be withdrawn completely tax-free if you comply
with "qualifying distribution" rules. By contrast, contributions to a
traditional IRA may or may not be deductible and therefore may or may
not be withdrawn tax free in accordance with the "qualifying
distribution" rules.
Whether or not you can deduct contributions to a traditional IRA may
depend on your income level when you are covered by an employer’s
retirement plan. For tax year 2005, single taxpayers who are covered by
an employer's retirement plan can make deductible IRA contributions
subject to an adjusted gross income phaseout range of $50,000 and
$60,000. For married taxpayers filing jointly, an adjusted gross income
phaseout range of $70,000 and $80,000 applies in 2005 if an IRA
participant is covered by an employer plan. The phaseout range for an
IRA participant who is not covered by a plan but whose spouse is covered
is $150,000 - $160,000 of income in a joint return.
What do these rules mean? If you're single, under age 50, covered by an
employer plan, and your adjusted gross income exceeds $60,000 in 2005,
you cannot deduct any portion of your maximum $4,000 traditional IRA
contribution. You can still contribute the $4,000 annual maximum to an
IRA, but your entire contribution will be nondeductible. The same logic
applies to joint filers, subject to the limitations described above.
So is the Roth better than the traditional IRA? That depends. For
taxpayers that are only allowed to make nondeductible IRA contributions,
the Roth IRA is clearly preferable. That's because contributions to a
Roth IRA may be withdrawn tax-free as "qualifying distributions."
Qualifying distributions will also not be subject the 10% early
withdrawal penalty tax.
To satisfy the qualifying distribution rules you must not draw from the
Roth IRA for the first five years and meet one of six other
requirements:
1) The distribution is made after you reach age 59 ½.
2) The distribution is paid because of your death or disability.
3) The distribution consists of substantial equal periodic payments.
4) The distribution is used for qualifying medical or health insurance
expenses.
5) The distribution is used for higher education expenses.
6) The distribution is used for a first home purchase and is limited to
$10,000
Taxpayers with existing traditional IRA accounts can choose to rollover
their IRAs into Roth IRAs. That means paying taxes now so you don't have
to pay them later. Whether you should do that depends on many factors
that are unique to your own situation. It also requires highly complex
"what if" computations that can only be handled by a computer and a
skilled tax professional. In fact, different software programs sometimes
give different answers, so you really have to be both a tax and computer
expert to do this important analysis correctly! We are both happy and
prepared to help you. Please don't hesitate to call if you have any
questions. |
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