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ROTH IRA

What is a Roth Individual Retirement Account (Roth IRA)?
A Roth IRA is a type of tax-preferred savings and investment account authorized by Internal Revenue Code section 408A. The Roth IRA allows you to accumulate assets for retirement purposes and for other purposes.

What is the tax benefit realized from a Roth IRA?
A Roth IRA will produce tax-free income if certain rules are met. You or your beneficiary(ies) will not be required to include in income, for income tax purposes, a distribution paid from a Roth IRA, whether it be the return of a contribution or the account’s earnings, if certain rules are met.

What is the basic concept of a Roth IRA, and what are the associated tax benefits?
If you are eligible, you may make contributions, within limits, to the Roth IRA. You make these contributions with after-tax dollars. The earnings realized by the Roth IRA are not presently taxed, and if certain distribution rules are met, will never be taxed. For example, if you are age 42 on January 1, 2001, and you contribute $1,000 a year for 34 years (2001-2034) to a Roth IRA, then your contributions of $34,000 would accumulate to $110,434.88 as of December 31, 2034, if an earnings rate of 6% compounded annually was realized. You and your beneficiary(ies) would, of course, not pay any federal income tax on the contribution amount of $34,000 when distributed, because you cannot claim a tax deduction for your contributions. However, the great tax benefit to be realized from a Roth IRA is that you and your beneficiary(ies) will not have to include in your taxable income the earnings of $76,434.88 (and subsequent future earnings) when distributed to you or your beneficiary(ies) as long as the distributions are qualified distributions as defined later. You are not required to withdraw any required distribution amount from a Roth IRA while you are alive. And, even though your beneficiaries will be required to receive certain required distributions, these distributions will be made over a number of years. This means the funds (contributions and earnings) within your Roth IRA which your beneficiary(ies) will have inherited will continue to accumulate for some time within the inherited Roth IRA and will not be taxed when distributed. These are great tax benefits.

THE IRA CONTRIBUTION RULES

When do I have to establish the Roth IRA?
You have until the due date (without extensions) for filing your federal income tax return, normally April 15, to establish and fund your Roth IRA for the previous tax year.

Am I eligible to contribute to a Roth IRA?
You are eligible if you satisfy the following two requirements: (1) you must have earned income or compensation; and (2) you meet certain income limitations. Be aware that you are eligible to make contributions to a Roth IRA even though you are age 701/2 or older. For a given year, you may be ineligible to contribute to a Roth IRA, but still be eligible to contribute to a traditional IRA and/or the Education IRA.

What are the income limits for eligibility purposes?
If your income (and your spouse’s income, if you are married) is too high, you will not be eligible to make a contribution to a Roth IRA. If you are single, you become ineligible when your adjusted gross income is $110,000 or greater. If you are married, and file a joint return, you become ineligible when the combined adjusted gross income (AGI) of you and your spouse is $160,000 or greater. If you are married and file a separate return, you become ineligible when your adjusted gross income is $10,000 or greater.

How much can I contribute to my Roth IRA for the 2001 tax year?
You are eligible to contribute the lesser of 100% of your compensation, or $2,000, as reduced by (1) application of the special income and filing status limitation rule and (2) any amount you contributed to your traditional IRA for the same tax year.

How much am I eligible to contribute to my Roth IRA for the 2002 tax year if I will NOT be at least age 50 as of December 31, 2002?
You are eligible to contribute the lesser of 100% of your compensation, or $3,000, as reduced by (1) application of the special income and filing status limitation rule and (2) any amount you contributed to your traditional IRA for the same tax year.

How much am I eligible to contribute to my Roth IRA for the 2002 tax year if I will be at least age 50 as of December 31, 2002?
You are eligible to contribute the lesser of 100% of your compensation, or $3,500, as reduced by (1) application of the special income and filing status limitation rule and (2) any amount you contributed to your traditional IRA for the same tax year.

What are the contribution limits for a person who is not age 50 or older?

May my spouse or I use the spousal IRA contribution rules to make a contribution to our respective Roth IRA for the 2001 and/or 2002 tax year?
Yes. You (or your spouse) will be eligible to make a spousal contribution to a Roth IRA if the following rules are satisfied:

• You and your spouse must each have your own Roth IRA.
• You must be married as of the end of the tax year (i.e. December 31).
• You must file a joint income tax return.
• You must have compensation includible in gross income which is less than that of your spouse.

Your annual Roth IRA contribution will be limited to the lesser of (1) $2,000, $3,000 or $3,500, as applicable; or (2) the sum of your compensation which is includible in gross income for such year plus the compensation of your spouse as reduced by your spouse’s contribution to his or her own traditional IRA and Roth IRA. In addition, when your Roth IRA contribution is aggregated with your traditional IRA contributions and with the contributions of your spouse, the maximum permissible amount for all IRAs will be the lesser of $4,000, $6,000, $6,500 or $7,000, as applicable, or 100% of your combined incomes.

Does EGTRRA contain a Sunset provision?
Yes. The changes made by EGTRRA shall not apply to any tax year, plan year, or limitation year after December 31, 2010, or to the estates of individuals dying, gifts made, or generation-skipping transfers after December 31, 2010. Thus, the law which existed prior to EGTRRA will again be the law. For example, the IRA contribution limit will again be $2,000.

How do the larger contribution limits impact a person who is only age 20 in the year 2002?
A person will receive the larger standard contribution limits (i.e. $3,000, $4,000 and $5,000) for the first 30 years, and then will receive the 50+ contribution limits for the next 21 years. The chart below shows that $1,098,186 will be accumulated under the EGTRRA contribution limits as compared to $463,712 if the contribution limit had remained at $2,000. This difference of $634,474 is very substantial. Of this amount, $165,000 is due to the increase in the contribution limits and the remainder is due to accumulated earnings. For purposes of preparing this chart, it has been assumed that the Sunset provision will not go into effect.

What will be the result if I am age 50 in 2002, and I elect to contribute the maximum amount permitted by EGTRRA to a traditional IRA?
The following chart shows how a person’s IRA balance will be larger with the new contribution limits than with the $2,000 limit, and how the IRA balance will be larger for a 50+ person than for a person younger than age 50. The following assumptions apply to the preparation of this chart: (1) the contribution amount is deposited January 1 of each year (2) interest of 5% is compounded and paid annually on December 31 (3) the maximum allowable contribution is made under EGTRRA, and (4) the contribution limits will remain the same and the sunset rules will not go into effect in 2011.

Should I take advantage of these higher contribution limits even if they are in effect for only 9 years?
Definitely. Because there is no certainty that the higher contribution limits will be available after December 31, 2010, you will want to be sure to use the higher contribution limits when you can. This is true whether you are age 20 or age 50. You may not get this chance again. The following two charts illustrate the increase in the account balances over the period of 2002-2022 if you, as either a person age 20 or as a person aged 50, make the higher contributions limits for 2002-2010 versus not making such contributions (i.e. only contribute $2,000).

To what extent may I be entitled to a new tax credit for my IRA contributions for the 2002-2006 tax years?
You may be eligible for a new tax credit for contributions you make to your traditional and/or Roth IRA. A formula is used to calculate your credit. Your credit may vary from $1 to $1,000, depending on the amount you contribute to your IRA, your filing status and your modified adjusted gross income. If you meet the following requirements for a given tax year, then you will qualify for this new credit:

1. Be at least 18 years of age as of December 31 of such year.
2. Not be a dependent on someone else’s tax return
3. Not be a student as defined in Internal Revenue Code section 25B(c)
4. Have adjusted gross income under certain limits which are based on your filing status:
   • Joint filers - $50,000.01
   • Head-of-Household - $37,500.01
   • All other filers (including Married, filing separately) - $25,000.01
5. Must not have received certain distributions which disqualify you from claiming the credit, or certain distributions which were made to your spouse.

Because of the complexity of this credit, you will want to review IRS Publication 590 for a complete explanation.

ROLLOVER CONTRIBUTIONS

If I receive a distribution from one Roth IRA, may I roll over the funds to a second Roth IRA?
Yes. Distributed funds, unless rolled over, would need to be partially included in income as discussed below. The purpose of a rollover is to change an otherwise taxable event into a nontaxable event. The rules which govern a “Roth-to-Roth” rollover are the same as for a rollover from one traditional IRA to another traditional IRA. You must comply with the 60-day rule and you are only entitled to one such rollover within a 12-month period.

May I roll over funds from a qualified plan or a section 403(b) plan to a Roth IRA?
No. Funds may be rolled over into a Roth IRA only if the funds are distributed from another Roth IRA or a traditional IRA. The rules would permit you to roll over your qualified plan funds into a traditional IRA and then roll over such funds to a Roth IRA.

May I roll over or convert part or all of my traditional IRA to a Roth IRA?
Maybe. Only certain people qualify for such a rollover or conversion. This situation presents a new and unique meaning of “rollover.” Normally, there is no taxation when a rollover occurs. This is not the case with this type of rollover. You may find it advantageous to incur the tax consequences of a present distribution in order to qualify to earn the right to have no taxation when the earnings are ultimately distributed from the Roth IRA.

In order to roll over or convert traditional IRA funds to a Roth IRA, you must have adjusted gross income of $100,000 or less in the year of the rollover, and if married, you must file a joint tax return. Special warning: The IRS has stated that they construe the Code section 408A(c)(3)(B) requirement that the taxpayer’s adjusted gross income must not exceed $100,000 to mean that the combined adjusted gross income of persons who are married and who file a joint return must not exceed $100,000.

There are three ways to accomplish a conversion from a traditional IRA to a Roth IRA.

• Method #1. An amount distributed from a traditional IRA is contributed (i.e. rolled over) to a Roth IRA within 60 days of the distribution.
• Method #2. An amount in a traditional IRA is transferred to a Roth IRA maintained by the same custodian or trustee.
• Method #3. An amount in a traditional IRA is transferred in a custodian/trustee-to-custodian/trustee transfer from the custodian/trustee of the traditional IRA to the custodian/ trustee of the Roth IRA.

Whatever conversion method is used, the custodian/trustee of the traditional IRA will prepare a Form 1099-R to report the distribution, and the custodian/trustee of the Roth IRA will prepare a 5498 to report the conversion contribution.

What are the tax consequences of receiving a distribution from a traditional IRA and “rolling over” the distribution to a Roth IRA?
In general, the amount distributed to you from your traditional IRA will be included in your income in the year of receipt and will be subject to income taxes for that year. The 10% premature distribution excise tax, however, will not be owed even if you are younger than age 591/2.

THE WITHDRAWL RULES

When may I start to withdraw money or assets from my Roth IRA?
You may begin withdrawals at any time. However, you will want to understand the income tax consequences of taking distributions at certain times.

What distributions from a Roth IRA will be tax-free?
“ Qualified distributions” will be tax-free. To be a qualified distribution, the distribution must occur after you have met the five-year holding requirement, and the distribution is made to you (1) after you have attained age 591/2 , (2) after you have become disabled, (3) because of a first-time home purchase, or (4) to your beneficiary after your death.

What distributions from a Roth IRA will be taxed?
To the extent that a nonqualified distribution is the return of the earnings on your contributions, you will need to include this distribution amount in income and pay the related tax.

Does the law define the order for distributions?
Yes. The law mandates the following order for distributions: (1) from regular/annual contributions; (2) from conversion contributions on a first-in-first-out basis and (3) from earnings. The order is determined as of the end of the taxable year, and each category must be exhausted before the next is used. With respect to a conversion contribution, it is treated as being made first from the portion, if any, that was includible in gross income as a result of the conversion.

Will the 10% excise tax ever be assessed?
Yes. If you are not yet age 591/2 (and none of the other exceptions apply at the time you withdraw funds from your Roth IRA), then you will be liable to pay the 10% excise tax on that portion of the distribution which is taxable. You will not pay the 10% excise tax when your contributions or basis is returned to you.

Are there exceptions to the age 591/2 rule?
Yes. You may qualify for an exception if you are in one of the following situations. (1)You have unreimbursed medial expenses that are more than 7.5% of your adjusted gross income. (2) The distributions are not more than the cost of your medical insurance. (3) You are disabled. (4) You are the beneficiary of a deceased IRA owner. (5) You are receiving distribution in the form of an annuity. (6) The distributions are not more than your qualified higher education expenses. (7) You use the distributions to buy, build, or rebuild a first home. (8) The distribution is of contributions returned before the due date of your tax return. (9) The distribution is due to an IRS levy of the qualified plan. Refer to IRS Publication 590 for an explanation of the exceptions.

When will I have met the five-year rule?
The five-year period is considered to start on January 1 of the year for which the first contribution to a Roth IRA is made. All Roth IRA contributions, including rollovers, are aggregated for purposes of satisfying the five-year rule. Exception: a distinct five-year period applies to inherited Roth IRAs.

Are there rules which allow me to correct or undo a Roth contribution?
Yes. You may correct a Roth contribution by either withdrawing it according to the withdrawal of excess contribution rules or by recharacterizing your Roth contribution according to special recharacterization rules. Talk with us if you want additional information on these subjects.

Must I commence required minimum distributions from my Roth IRA at age 701/2?
No. The required minimum distribution rules for living accountholders (age 701/2 ) do not apply to distributions from a Roth IRA.

What happens to my Roth IRA after I die?
The funds or assets in your Roth IRA will be paid to your designated beneficiaries in any way which either you or they select as long as the required minimum distribution rules for inherited Roth IRAs are satisfied over the beneficiary’s life expectancy. As mentioned previously, your beneficiary will generally be able to maintain your Roth IRA as an inherited Roth IRA so that there will continue to be tax free earnings for many years after your death.

Will my Roth IRA be insured by the FDIC?
Yes, if you have invested your Roth IRA funds in savings or time deposits as offered by an insured institution. FDIC insurance applies to “certain” deposits of an insured institution such as saving accounts and time deposits. Some investments, such as mutual funds, stocks, and bonds are not eligible for FDIC insurance coverage. Funds deposited in a Roth IRA will be aggregated with funds deposited in any other IRA (except Coverdell Education Savings Accounts) and certain other pension type deposits at the same insured institution, for the same person. That is, funds deposited in all IRAs (traditional and Roth) at one insured depository institution are added together and insured in aggregate for a maximum of $100,000.

How do I establish a Roth IRA?
Just come in and talk with us or give us a call.