For those who don’t qualify for deductible Traditional IRAs – and even for those who do – the Roth has become a very attractive alternative. There are no deductions for contributions to the Roth IRA. Instead, you pay your taxes upfront. So, when retirement rolls around, 100% of the money you withdraw is yours to keep, free of taxes. Like a Traditional IRA, if you fall within certain income limits, you may qualify for the IRA Tax Credit.
The Roth IRA annual contribution limits for individuals who have earned income are as follows:
| Year | Contribution Amount |
| 2007 | $4,000 |
| 2008 | $5,000 |
| 2009 and later | $5,000 plus indexed adjustment |
Individuals who have reached age 50 or older before the end of the year are allowed to make catch-up contributions in addition to their regular annual IRA contribution. The catch-up amount is as follows:
| Year | Catch Up Amount |
| 2007 and later | $1,000 |
If you turn age 50 or older, you are allowed to contribute $1,000, in addition to your regular contribution as long as you have earned income to support the catch-up amount. Your total 2007 contribution limit will then be $5,000. In 2008, your total contribution limit will be $6,000.
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Just as with deductible Traditional IRAs, there are income caps for taking advantage of the Roth IRA. For singles, the 2007 Roth IRA contribution is phased out for Modified Adjusted Gross Income (MAGI) from $99,000 to $114,000. For married couples filling jointly, the phaseout runs from $156,000 to 166,000. In 2008, for singles the Roth IRA contribution is phased out from $101,000 to $116,000. Married couples filing jointly, the phaseout runs from $159,000 to $169,000.
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For Roth IRA withdrawals to be free from Federal income taxes, two requirements must be met:
First, the account must be in existence for five years. This does not mean that all contributions must stay in the account for five years before their earnings are tax-free. It only means that five years must pass from the time of the first contribution. If you started a Roth IRA anytime in 2004, your withdrawals may be tax-free beginning in 2009.
Second, at the time of the withdrawal, the account owner must be at least 59 1/2 years old, or the distribution must result from the owner’s disability or death. The account owner may also take a tax-free distribution of up to $10,000 for qualified, first-time homebuyers expenses.
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With the Roth IRA, the withdrawal of contributions comes first, and contributions are returned penalty-free and tax-free, regardless of what the withdrawal is used for. This is true even for withdrawals that occur within five years of establishing the account. (Special rules apply to withdrawals taken from a converted Roth IRA before the 5-year period has ended.) The earnings in a Roth IRA are withdrawn last and are subject to penalty if the two conditions for tax-free withdrawals are not met.
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During retirement the Roth IRA offers far greater flexibility and simplicity in planning distributions. There are no elections to be made when one reaches age 70 1/2. There are no mandatory distributions and no tax penalties for allowing the account to grow undisturbed, tax-free. What's more, if you have earned income, contributions to the Roth IRA are permitted after age 70 1/2 as well.
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There's no simple answer to which one is better. No single rule of thumb applies to everyone. Many people need the current income tax deduction to be able to set aside a full contribution amount. For them the Traditional IRA may be the better choice. But they will have less money available during retirement than those who choose the Roth IRA and put aside after-tax dollars for future tax-free withdrawals.
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Congress recognized that the Roth IRA would be attractive to many taxpayers, including those who already had established Traditional IRAs. Those who prefer the Roth IRA approach of total tax freedom can consider converting their Traditional IRA to a Roth IRA at any time.
Only taxpayers whose Modified Adjusted Gross Income (MAGI) is below $100,000 (whether single or married filling jointly) are allowed to convert Traditional IRAs into Roth IRAs. Whether the rollover will be a good idea for those who are eligible depends upon how much time remains before the funds will be needed, the expected rate of return on the assets and the taxpayer's marginal tax brackets now and during retirement.
A conversion requires you to pay income taxes on taxable amounts rolled into the Roth IRA. With a nondeductible IRA, for example, only the earnings would be subject to tax. For Traditional IRAs, the entire value of the rollover would be included in the taxpayer's income.
- Will your Modified Adjusted Gross Income (MAGI) be less than $100,000?
- Do you expect to be able to leave your IRA funds untouched for at least five years?
- Do you expect your tax rate after retirement to be as high as it is now?
- Can you afford to pay the taxes due on the conversion from the Traditional IRA to the Roth IRA "out of pocket"?
If you answered yes to these questions, converting to a People's United Roth IRA could be the best choice for you. You will also want to consult your tax advisor as you make your decision.
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