Template:IRA Sidebar Template:Back to Bogleheads Retirement Planning Start-Up Kit An individual retirement arrangement, or IRA, is a personal savings plan which allows you to set aside money for retirement, while offering you tax advantages. You may be able to deduct some or all of your contributions to your IRA (Traditional IRA) and pay taxes when you withdraw from the IRA; or receive no tax deduction on your contributions (Roth IRA), with, subject to certain restrictions, no tax imposed on your distributions. Amounts in your IRA, including earnings, generally are not taxed until distributed to you. IRA's cannot be owned jointly. However, any amounts remaining in your IRA upon your death can be paid to your beneficiary or beneficiaries. Roth IRAs were established by the Taxpayer Relief Act of 1997.
Types of IRAs
See also: Traditional IRA
There are two basic types of IRA's, traditional and Roth. The table below reviews some of the differences between the two account structures.
|Traditional IRA||Roth IRA|
As a general rule of thumb, the decision as to which IRA an investor elects to use is a function of expected present and future tax rates. Thus a Traditional IRA should be considered if the present marginal tax rate is expected to be higher than the future marginal rate at distribution; The Roth IRA should be considered if the present marginal tax rate is expected to be lower than the future marginal rate at distribution. If the outlook for tax rates is uncertain, one should consider diversifying contributions (or conversions) between the two account types. A Roth IRA may also be a strong candidate for consideration if the account is used as an estate planning tool. For the original account owner (and spousal inheritors) there are no required minimum distributions to deplete the account for subsequent beneficiaries. If one faces estate tax a Roth conversion can produce tax savings to the estate since the income tax paid on the conversion both reduces the estate and renders tax savings since the income tax rate is lower than the estate tax rate. 
Contribution Eligibility and Limits
Your ability to contribute to a Roth IRA is limited depending on your filing status and the level of your "modified adjusted gross income". These income limits change year to year due to inflation adjustment. You can find these income limits in IRS Publication 590: Roth IRAs Your modified AGI for Roth IRA purposes is your adjusted gross income (AGI) as shown on your tax return modified as follows;
|1.Subtract the following:
2. Add the following deductions and exclusions:
IRA contributions are also limited by the amount of your earned income. The total amount you can contribute to your IRAs cannot be greater than the amount of your earned income for the year of the contribution. For married couples filing jointly, the earned income of either spouse can be used to make the contributions to each person’s IRAs. It makes no difference which spouse has the earned income, but the total earned income cannot be less than the total of the IRA contributions for both individuals. The IRS defines earned income as the taxable income and wages you get for working. Either working for someone who pays you or working for a business you own. If you are working for someone else, earned income will be reported on line 3 of your W-2. If you are working for a business you own, your earned income is the net income reported on the Schedule C less 50% of the self-employment taxes you pay. Other types of income do not fit the definition of earned income and cannot be used for Roth IRA contributions.
These contribution limits apply to the total you can contribute to all of your IRAs. You cannot contribute the maximum amount to a traditional IRA and also make a contribution to a Roth IRA. The contribution maximum can be divided between the IRAs in any way you wish but the total cannot exceed the limit. Beginning in 2009, contribution limits are inflation-adjusted in $500 increments. The table below provides the historical maximum annual Roth contribution limits.
|Year||Age 49 and Below||Age 50 and Above|
|1998 - 2001||$2,000||$2,000|
|2002 - 2004||$3,000||$3,500|
|2006 - 2007||$4,000||$5,000|
|2008 - 2010||$5,000||$6,000|
Conversion to Roth IRA
Conversions from a Traditional IRA to a Roth IRA require one to pay the tax due (without penalty tax) on any previously untaxed Traditional IRA assets converted. For an analysis of the potential benefits of a conversion, see Roth IRA conversion. In general, conversions work best when one is in a low tax bracket and when the source of funds for paying the tax are available outside of the IRA. If the tax is paid out of the converted assets, the payment is considered an early distribution and is subject to both income tax, and if one is under age 59 1/2, a 10 percent penalty tax.
You can convert a Traditional IRA to a Roth IRA if:
- your Modified AGI (see above) does not exceed $100,000, and
- you are not married filing separately.
|See The rules for Roth conversions are changing in 2010|
New conversion rules for 2010:
- Beginning in 2010, the modified AGI and filing status requirements for converting a traditional IRA to a Roth IRA are eliminated.
- For 2010 only, you may choose to pay taxes on conversion either all in 2010 or in equal amounts in 2011 and 2012.
For the tax consequences of taking a distribution of converted assets see Distributions below.
For more complete information on conversions, refer to Fairmark's Roth IRA Guide: Conversions.
If one wishes to undo a conversion, one does so by executing an IRA recharacterization. Undoing a conversion might result from finding that:
- One has earned too much income during the year to qualify for a conversion.
- One finds that one does not have sufficient funds to pay the conversion tax.
- The market value of the converted assets has fallen in price after the conversion and one can save tax by recharacterizing the conversion and then, in accordance with IRS restrictions, reconverting the assets at the lower value.
For more complete information on recharacterizations, refer to Fairmark's Roth IRA Guide: Roth Recharacterizations.
|Order of Distributions
The amounts you withdraw from a Roth IRA are considered to consist of the following amounts, in the following order. In each case, you move to the next category when the lifetime total of distributions from all your Roth IRAs exceed the preceding category.
Treatment of Distributions
The tax treatment of the different categories of distributions may be summarized as follows:
|-Fairmark: Roth IRA Distribution Overview|
While a Roth IRA does not impose required minimal distributions for the original Roth IRA owner, or for a spouse who elects to treat an inherited Roth IRA as one's own in a spousal rollover, non-spousal inheritors are required to take required minimal distributions of the Roth over their life expectancies.
In addition, there can be some tax consequences to taking distributions from a Roth IRA prior to age 59 1/2 or before the Roth has been held for a minimum of five years for both contributions as well as for each Roth conversion. The specific ordering rules for Roth IRA distributions and the tax consequences of the distributions are discussed in the sidebar quote box, courtesy of Fairmark.
- See Non-deductible Traditional IRA
- Penalty free withdrawals can also be made by instituting a defined series of Substantially Equal Periodic Payments from an IRA. See SEPP:Substantially Equal Periodic Payments.
- Bruno, Maria A.,and Jaconetti, Colleen M., The IRA opportunity: To Roth or not to Roth?, Vanguard Research, (May, 2011).
- IRS Publication 590: Roth IRAs
- Choate, Natalie, "Life and Death Planning for Retirement Benefits 6th Edition 2006" p.247. ISBN 0-9649440-7-3
- IRS Publication 590 (2009), Individual Retirement Arrangements (IRAs)
- IRS Publication 590 (2009), Individual Retirement Arrangements (IRAs) Applies for any 2010 rollover from an IRA, except from Roth IRA to Roth IRA.
- Fairmark: Roth IRA Distribution Overview
- Exceptions to the early withdrawal penalty tax on converted assets include total disability, or death. Choate, Natalie, "Life and Death Planning for Retirement Benefits 6th Edition 2006" p.248. ISBN 0-9649440-7-3
- Fairmark: Roth IRA Distribution Overview
Papers: Roth IRAs
Papers: Roth 401-k and Roth 403-b Plans