CARL WATTS & ASSOCIATES

May 25, 2015

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Roth IRA - What You May
Not Know
As the title suggests, our intention here is to offer you less known facts about a Roth IRA. After all, you already know that a Roth IRA is an individual retirement plan that can be either an account or an annuity and which is tax advantaged, under the U.S. law, provided certain conditions are met.

You may not know that the Roth IRA was established by the Taxpayer Relief Act of 1997 and named for its chief legislative sponsor, Senator William Roth of Delaware.

You may have heard of designated Roth accounts, but please pay attention, they are not the same as Roth IRAs. A designated Roth account is a separate account in a 401(k), 403(b) or governmental 457(b) plan that holds designated Roth contributions.

You can open a Roth IRA with banks, mutual fund companies, brokerage firms, and insurance companies, and contribute to your account regardless of your age.

Although only individuals with income below certain levels can contribute to a Roth IRA, your stay-at-home spouse can also have a Roth IRA if you file a joint return. Just remember that the account or annuity must be designated as a Roth IRA when it is set up.

If you make contributions only to Roth IRAs, your contribution limit generally is the lesser of $5,500 ($6,500 if you are age 50 or older), or your taxable compensation.

If contributions are made to both Roth IRAs and traditional IRAs established for your benefit, your contribution limit for Roth IRAs generally is the same as your limit would be if contributions were made only to Roth IRAs, but then reduced by all contributions for the year to all IRAs other than Roth IRAs (employer contributions under a SEP or SIMPLE IRA plan do not affect this limit).

As mentioned above, your contribution to a Roth IRA is also affected by the amount of your modified adjusted gross income (MAGI). Here are the amounts set for 2015:

  • If your filing status is married filing jointly (or qualifying widow/widower), you can contribute the full amount if your MAGI is below $183,000. Your contribution is reduced if your MAGI is between $183,000 and $193,000. You cannot contribute to a Roth IRA if your MAGI is above $193,000.
  • If your filing status is single (head of household, or married filing separately), you can contribute the full amount if your MAGI is below $116,000. Your contribution is reduced if your MAGI is between $116,000 and $131,000. You cannot contribute to a Roth IRA if your MAGI is above $131,000.

Contributions to your Roth IRA are not tax-deductible, they are made with after-tax dollars, which means that you will never pay tax when you take a qualified distribution from your Roth IRA and that you can have access to your contributions at any time, without any penalty.

If you withdraw contributions (including any net earnings on the contributions) by the due date of your return for the year in which you made the contribution, the contributions are treated as if you never made them. If you have an extension of time to file your return, you can withdraw the contributions and earnings by the extended due date. The withdrawal of contributions is tax free, but you must include the earnings on the contributions in income for the year in which you made the contributions.





If you want to withdraw Roth IRA funds before you turn 59 1/2, you may be responsible for paying a 10-percent penalty on the Roth's earnings -- as opposed to your contributions, which are never penalized.

Roth IRAs are also subject to the five-year rule, which stipulates that you cannot take a qualified distribution until the account has been open five years, even if you turn 59 1/2 in the meantime. The same is also true for funds you roll over to a Roth IRA--you must let them sit for five years.

If you want to take out some of those investment earnings, you can do so one time -- you are allowed to take up to $10,000 of your earnings to put towards buying a home if you are a first-time homebuyer.

There are no required minimum distributions (RMDs) with a Roth IRA. You never have to withdraw money if you don’t want to. It is important to note that this privilege disappears upon the death of the owner.

If you inherit a Roth IRA, you must take RMDs (but the RMDs are still tax-free). Inheriting a Roth IRA is very similar to receiving the proceeds of a paid-out life insurance policy.

Qualified Roth distributions do not affect the calculation of taxable social security benefits.

Funds that reside in a Roth IRA cannot be used as collateral for a loan per current IRS rules and therefore cannot be used for financial leveraging or cash management tool for investment purposes.

If you receive a distribution from your Roth IRA that is not a qualified distribution, part of it may be taxable. There is a set order in which contributions (including conversion contributions and rollover contributions from qualified retirement plans) and earnings are considered to be distributed from your Roth IRA. But with all the rules and calculations necessary, you will be better by getting help from a tax professional.

You can withdraw all or part of the assets from a traditional IRA and reinvest them (within 60 days) in a Roth IRA. The amount that you withdraw and timely convert to the Roth IRA is called a conversion contribution. If properly (and timely) rolled over, the 10% additional tax on early distributions will not apply. However, a part or all of the distribution from your traditional IRA may be included in gross income and subjected to ordinary income tax.

You must roll over into the Roth IRA the same property you received from the traditional IRA. You can roll over part of the withdrawal into a Roth IRA and keep the rest of it. The amount you keep will generally be taxable (except for the part that is a return of nondeductible contributions) and may be subject to the 10% additional tax on early distributions.

As everybody knows, there is no one-formula-fits-all in this matter, as in many others.

When you choose to make contributions to a Roth IRA, you choose to pay taxes on those contributions at your current tax rate. The Roth IRA may not be the best choice for you if, for instance, Congress lowers income tax rates, or if you will be in a much lower tax rate when you retire, or you move to a low income or no income tax state.

With your financial future at stake, be it at retirement age or before, advice from professional consultants is a must, unless, of course, you are one of them!
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