Characteristics of the Roth IRA - Advantages/Disadvantages, Contribution Limits, Eligibility (Single, Joint & Married but Filing Separately Filers) and Income Limits

(July 13th, 2008)

The purpose of this article is to give you an in depth view of the Roth IRA with its advantages and disadvantages, income limits & eligibility. Named after its founder Senator William Roth of Delaware, the Roth IRA (Individual Retirement Account) was established in 1998 under the Public Law 105-34. While Traditional IRA may only be limited to where your corporation invests in, a Roth IRA gives you a wide array of investment choices; ranging from common stocks, mutual funds, commodities & futures, certificates of deposit as well as real estate). Here are the contribution limits of the Roth IRA.

Starting 2008, contribution limits will be raised by $500 a year to account for inflation. Here are the advantages and disadvantages of the Roth IRA.

Advantages

- If money was converted from a Traditional IRA to a Roth IRA, the investor can withdraw up to the total amount of the converted amount so long as the money has stayed in the Roth IRA for atleast 5 years.

- Withdrawals of capital gains (any earnings made on the invested amounts) are tax-free if the investor has reached 59 and 1é2 years of age.

- Direct contributions to a Roth IRA can be withdrawn tax-free and without any penalties since they have already been taxed when the contributions were made.

- Up to $10,000 can be withdrawn from the Roth IRA to purchase a principal residence. The house must be bought either by the Roth IRA owner, their spouse, or ancestors or descendants. The trick here is the Roth IRA owner must not have owned a home within the last 24 months to qualify for this clause.

- Contributions to a Roth IRA can be made even if the investor contributes to other retirement plans such as the 401k, 403b or qualified education savings plan.

- If a Roth IRA investor dies and his spouse becomes the sole beneficiary of the funds, he or she can combine the two separate Roth IRA accounts into 1 without any penalties or tax.

- If the Roth IRA investor expects his tax bracket to be higher upon retirement, there is an advantage to making Roth IRA contributions now. Since these contributions are taxed at the current lower rate, the investor does not have to worry about paying taxes when he hits retirement. For example if the investor is currently in an 18% tax bracket, a $10,000 contribution to a Roth IRA would incur $1800 in taxes. If the investor expects to be in the 30% tax bracket upon retirement, the same $10,000 would incur $3000 in taxes. Thus the advantage of Roth IRA is paying the tax now and not worry about having to pay Uncle Sam when you hit retirement.

- Unlike all other retirement plans including the Roth 401k that require you to take out distributions by April 1st, the Roth IRA does not require you to take out minimum required distributions (MRDs).

- Any earnings from the Roth IRA are not taxable if withdrawn after 5 years of the establishment of the Roth IRA, and the participant must be 59 and 1é2 years of age at the time of withdrawal.

Disadvantages

- The main disadvantage of a Roth IRA is that any contributions you make now are NOT tax deductible and you will have to pay taxes on them.

- Eligibility for Roth IRA contributions is more strict than the Traditional IRA (see below for more details).

- Some people may not live up to retirement, so the tax advantages upon retirement may never be realized. An investor must live until his total Roth IRA contributions are withdrawn after retirement to realize the full benefits of this plan, which includes living well over the 70s. On the other hand, with a Traditional IRA, the government may never collect tax from you i.e if you die before retirement.

Eligibility for Roth IRA (Single, Joint & Married but Filing Separately Filers)

Investors can only contribute to a Roth IRA if their incomes fall in between these ranges (for the year 2007).

i) Single Filers - Up to $99,000 (Full Contribution) - $99,000 - $114,000 (Partial Contribution)

ii) Joint Filers - Up to $156,000 (Full Contribution) - $156,000 - $166,000 (Partial Contribution)

iii) Married Filing Separately - $0 (Full Contribution - If the Couple lived together for any part of the year) - $0 - $10,000 (Partial Contribution)

Roth IRA Conversion Limit

Investors can convert from a Traditional IRA to a Roth IRA if their modified adjusted gross income (MAGI) is less than $100,000 in the year of the conversion.