Roth IRAs
Roth Conversion Opportunity
Call us at 281-370-6622 to learn more about the opportunity now to convert to tax-free dollars.
You can convert traditional IRAs to Roth IRAs.
For this reason, it is good to understand more about Roth IRAs.
Basic Rules of Roth IRAs
Roth IRA is subject to the same rules that apply to a traditional IRA.
Same eligibility requirements (See below)
Same contribution deadline (April 15th following the tax year)
Same 10% early withdrawal penalty except in certain circumstances such as medical insurance premiums for unemployed persons, education expenses, and first time homebuyer’s expenses.
Some differences between a Roth IRA and a traditional IRA are:
Contributions to a Roth IRA are never deductible.
The buildup within a Roth IRA (e.g., interest, dividends and/or price appreciation) may be free from federal income tax when the individual withdraws money from the account, under current law.
Contributions:
For 2012, the maximum contribution that may generally be made to Roth IRAs and traditional IRAs is $5,000 and there is a $1,000 catch-up contributions for those that reach age 50 by the end of the tax year. For 2013, you can contribute $5,500 plus $1,000 if you were born in 1963.
This is the amount that may be contributed to both types of IRAs combined, not the amount that may be contributed to each type.
However, rollover contributions into a Roth IRA are not counted against the annual maximum. The ability of an individual to make a contribution to a Roth IRA depends upon the amount of the individual’s modified AGI.
Eligibility:
The modified AGI is the AGI without taking into account deductions for student loan interest, the education expense deduction, the contribution to traditional IRA deduction, or the income reported from the conversion of a traditional IRA into a Roth IRA.
For 2012, the MAGI phase-out range for single filers is $112,000 to $127,000 and for joint filers it is $178,000 to $188,000.
Six Reasons to Convert to a Roth IRA
The best reason to convert traditional IRAs to Roth IRAs is if you think paying taxes when you plant the seed rather then when at the time of harvest is a good idea. If so, it is better to pay the tax on retirement savings now and enjoy the benefit of tax free withdrawals later.
Upon retirement, the taxation of your Social Security income will be unaffected by your Roth IRA distributions and, thus, you may possibly avoid the chance that up to 85% of your Social Security income will be taxable.
All earnings in Roth IRAs are tax free upon withdrawal.
Unlike traditional IRAs, you are not required to take mandatory distributions at any age during your lifetime.
You may continue making Roth IRA contributions after age 70 ½ if you have earned income.
If you convert your traditional IRA to a Roth IRA, you will reduce your taxable estate, and you’ll be able to bequeath a pool of income-tax free money to your heirs.
Taxation of Roth IRA Distribution
“Qualified distributions” from a Roth IRA are not included in the recipient’s gross income and are not subject to the additional 10 percent penalty for early withdrawals. To be treated as a “qualified distribution,” the distribution must satisfy a five-year holding period and meet one of four requirements:
Made on or after the date on which the individual attains age 59 ½;
Made to a beneficiary (or the individual’s estate) on or after the individual’s death;
Attributable to the individual’s being disabled; or
A distribution to pay for “qualified first-time homebuyer expenses” ($10,000 lifetime maximum)
When an individual receives a “nonqualified distribution” from a Roth IRA, a portion of the distribution may be included in gross income. In order to determine the amount that is includible in gross income, specific ordering rules are applied. Under these rules, regular Roth contributions are deemed to be withdrawn first, then amounts transferred from traditional IRAs (starting with amounts first transferred).
Withdrawals of transferred amounts are treated as coming first from amounts that were included in income. Earnings are treated as withdrawn after contributions. Thus, no amount is included in gross income until all the after-tax contributions have been distributed.
If an individual receives a nonqualified distribution from a Roth IRA, a 10 percent penalty tax will generally apply to any portion of the distribution that is included in gross income. The 10 percent penalty will not apply if the distribution satisfies one of several exceptions (qualified higher education expenses, medical insurance while unemployed, and first time homebuyer’s expenses).
If an individual converts a traditional IRA to a Roth IRA and within the five-year period starting with the year in which an individual made the conversion contribution the individual takes a distribution from the Roth IRA of an amount that is attributable to the portion of the conversion contribution that was included in income, then generally the individual will be liable for the 10 percent penalty on early distributions except in the instances mentioned in the previous paragraph. The five-year period is separately determined for each conversion contribution made to a Roth IRA.
Mathematical Mechanics Behind Roth IRA conversions
Except for conversions done in 2010 (income tax due to conversion taxable income due in 2011 and 2012), you should pay enough in estimated federal tax payments to cover the additional tax that will be due on April 15thfollowing the tax year in which you convert the traditional IRA to a Roth IRA. Let us as your tax professional do an estimated return for you in order to calculate the additional tax that will be due.
Tactical Considerations
You have until December 31 to set up a conversion Roth IRA for the current year or funds for the Roth must be taken from the traditional IRA by December 31 as well. Contributory Roth IRAs for current year must be set up by April 15 of the following year.
If you have both tax-deductible and nondeductible IRAs, there’s another consideration. In short, you can’t convert only the nondeductible assets and avoid paying taxes on the conversion. Your conversion gets taxed based on the proportion of deductible and nondeductible asserts in all your IRAs.
Roth IRA Conversion Timeline
You have two years (2011 and 2012) to pay the tax due on any Roth conversions done in 2010. After that the tax must be paid in the year that the conversion is done. The deadline for recharacterizing a 2010 Roth conversion is October 15, 2011. If a recharacterization is not done by that date, the taxpayer will be locked into any tax liability from the conversion, including reporting income ratably over 2011 and 2012 if applicable.
Roth IRA Segregated Conversion Strategy
The five year holding period before making a qualified distribution is separately determined for each conversion contribution made to a Roth IRA, so there is some planning that may be necessary as you decide how much to convert to your Roth IRA in any one tax year.
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