Q: What’s a Roth IRA?
A: A Roth IRA is an individual retirement account (IRA) in which contributions of up to $5000 ($6000 if you’re 50 or better) are NOT deductible as they are with a traditional IRA. However, earnings can be withdrawn tax-free if you’re at least 59 ½ and had the Roth at least five years. Also, you don’t have to take required minimum distributions (RMDs) at age 70 ½, as you do with a traditional IRA or 401(k) plan. In addition, your Roth IRA will not be subject to income tax to your heirs.
Q: All earnings are tax-free? Why wouldn’t everyone do a Roth IRA?
A: Well, if your modified adjusted gross income is between $107,000 and $122,000 if you’re single, or between $169,000 and $179,000 if you’re married, you won’t be able to contribute the full amount. In addition, you need to make sure it makes sense for you: If you have many years to go before you’ll need to withdraw the money and you expect your tax bracket to be the same or higher, then the Roth IRA makes sense. If you think your tax bracket will be lower in retirement, stick with the traditional IRA.
Q: I want to do it—how do I go about it?
A: Open a Roth IRA with your financial institution and fund the contribution no later than April 16, 2012. Even if you extend your return to October 15, you still have to make a Roth contribution by April 16!
Q: I had a good year—guess I’m out of luck on the income threshholds.
A: You could do a Roth conversion (rather than contribution). There’s no income limit on the conversion for this year and beyond. With a Roth conversion you are converting a traditional IRA to a Roth IRA. This will result in taxable income in the year of conversion, but future earnings will be tax-free. There are many things to consider in determining whether a Roth conversion makes sense for you, such as what tax bracket you’re in now vs. retirement, ability to pay the additional tax on conversion, years until you retire, etc. Since conversions must occur by 12/31, if upon completing your tax return you realize that the Roth conversion doesn’t make sense for you after all, you can convert it back (“recharacterize”) to a traditional IRA by the due date of your return, including extensions.
Q: I had a terrible year—I don’t have the spare cash to make a Roth contribution.
A: You too should consider a Roth conversion. If during this difficult economy, your 2011 income has decreased more than usual, it might make sense for you to convert, in order to take advantage of some of the deductions you still have and/or to take advantage of the lower tax bracket you are currently in. Roth conversions for 2011 MUST be done by 12/31/11, so contact us to see if a Roth conversion might make sense for you.
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