Because contributions to a Roth IRA are made with after-tax dollars, withdrawals from a Roth IRA are generally free of income tax. You can contribute to a Roth IRA as long as your earned income is below max income limitations. Like a Traditional IRA, you are permitted to contribute up to $4,000 annually to a Roth IRA through 2007 and $5,000 in 2008. If you earn less than these amounts, you may contribute 100 percent of your earned income. You should note that if you contribute to both a Roth IRA and a Traditional IRA, your total contributions are not permitted to exceed the permitted amount.
Your annual Roth IRA contribution may be limited if your income exceeds certain amounts. If you file a joint return, you may make the full contribution provided your Adjusted Gross Income (AGI) is below $156,000 in 2007, $159,000 in 2008. If you file singly, the limit is $99,000 in 2007, $101,000 in 2008. For incomes at or above these limits, the allowable contribution phases out gradually. Check with your tax professional to see if you are eligible to contribute to a Roth IRA.
Traditional IRAs have mandatory withdrawal starting April 1 of the year after you turn age 70 1⁄2, but Roth IRAs have no minimum distribution requirements. Generally, Roth contributions can be withdrawn income tax free. You may incur a 10 percent penalty if you withdraw your contribution from a Roth IRA within the first five years after establishing a Roth IRA. Assuming you meet the five-year test, the requirements for penalty-free withdrawals from a Roth IRA are essentially the same as those for making withdrawals from a Traditional IRA, that is, there will generally not be a penalty if you die, are disabled, or if you are older than age 59 1⁄2.
Conversion from Traditional to Roth
Because funds withdrawn from a Roth IRA are not usually taxed, many people elect to convert all or part of a Traditional IRA to a Roth IRA. You may convert your Traditional IRA if you are single or if you are married and file a joint return. The conversion is permitted only when your AGI is less than $100,000 in the year of conversion. The converted amount (excluding nondeductible contributions) is included in your income for the year of the Roth IRA conversion. Recently enacted legislation will allow you to covert your Traditional IRA to a Roth IRA in 2010, regardless of your income level.
The decision to convert an existing Traditional IRA to a Roth IRA is an individual one. The amount converted from a Traditional IRA will be taxed as ordinary income. You must weigh several factors, including your current tax rate, what your tax rate may be in retirement, and your income now and in the future. You also need to consider whether or not you are able to pay the increased tax burden in the year you make the conversion. Consult with your financial advisor to determine if converting your Traditional IRA to a Roth IRA is right for you.
