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December 1, 1998
Year-End Tax Planning
The New Roth IRA
There's been much excitement over the newly introduced Roth IRA. The hoopla is understandable, as the Roth IRA is in many ways the tantalizing reverse of the regular IRA. Whereas traditionally you would sock away pre-tax money in an IRA, let it grow, and then pay taxes on your withdrawals, with the Roth you sock away post-tax money, let it grow, and then withdraw it… tax-free!
Despite this intriguing premise, the Roth isn't necessarily a godsend for everyone. It also comes with a boatload of complex rules and regulations that may be changing in the very near future due to pending legislation. A quick review of the law as currently written should help you determine whether or not the Roth is for you. But since the Roth IRA rules remain in flux, make sure to check out our online tax area now and then to keep abreast of changing Roth IRA rules.
Here's a quick look at the difference it makes. Remember, though, that your particular situation is likely to be different.
Let's say you're 35 years old and you invest $2,000 of your post-tax income into a Roth IRA each year, starting today. You earn a 12% annual return for the next 30 years until you retire at 65. By then, your contributions would have grown to about $600,000. With a Roth, that's your take-home pay. With a regular IRA, you would pay taxes on any withdrawals, netting just $510,000 assuming a 15% tax bracket during retirement, or merely $432,000 if you were still in the 28% bracket. So far, this is very convincing. But remember that if the $2,000 had gone directly into a traditional IRA, you would have reaped about $560 in tax savings. If that had also been invested, the total difference between the Roth and the regular IRA becomes much slimmer.
The devil -- or the angel, depending on your situation -- is in the details with the Roth IRA. So let's review the main details to consider. For starters, your total contribution for the tax year to a regular IRA and a Roth IRA can't exceed $2,000 -- combined.
But you can fund a Roth IRA even if you participate in a company retirement plan, such as a pension, profit-sharing plan, or 401(k) plan. So Fools who can should consider not only participating in their company's pension plan and maxxing out their contributions to their 401(k) plan, but also contributing $2,000 to a Roth IRA. In addition, any amounts rolled over to a Roth IRA in a "qualified rollover contribution" are not counted towards the $2,000 annual contribution limit.
There are no age limits on contributions to a Roth IRA. A child with earned income can make a Roth IRA contribution, if deemed appropriate. Not only that, but unlike a regular IRA, persons over the age of 70 1/2 can still make Roth IRA contributions as long as they have earned income and are not otherwise restricted by AGI limitations.
It just seems to get better and better, right? Well, here's the bad news. Not everyone is eligible for the Roth IRA. (That's right -- anyone reading this who travels in a personal jet and has a live-in nanny, masseuse, and dog groomer should probably just move on to the next chapter right now.) Here's who qualifies for what, based on Adjusted Gross Income (AGI):
Income Limitations
Single and Head of Household
Income: AGI = $95,000 or less
Rule: $2,000 contribution to a Roth IRA is fully allowable.
When AGI rises above $110,000, no Roth IRA contribution is allowable. Between the $95,000 and $110,000 "phase-out" range, only a partial Roth IRA contribution will be allowed.
Married Filing Jointly
Income: AGI = $150,000 or less
Rule: $2,000 contribution to a Roth IRA for each of the joint filers is fully allowable.
When AGI rises above $160,000, no Roth IRA contribution is allowable. Between the $150,000 and $160,000 "phase-out" range, only a partial Roth IRA contribution will be allowed.
Married Filing Separately
For married persons filing separate returns, the AGI limitation is so severe as to virtually prohibit a Roth IRA contribution. For married/separate filers, the "phase-out" range is between $0 and $10,000. You read that right -- if you're married and filing separately and your AGI is more than $10,000, to paraphrase the "Soup Nazi" from Seinfeld, "No Roth IRA contribution for you!"
If you fall into the "phase-out" category, it means that you'll have to crunch a bunch of numbers to determine how much you can contribute toward a Roth IRA. More details on how to do this are available at the Motley Fool online, in our tax strategies area. Your friends at the IRS also offer a wealth of information on the Roth, in their Publication 590.
The deadline for contributing to a Roth IRA is the same as the deadline for filing your tax return, not including extensions. So if you are qualified to make a 1998 Roth IRA contribution, that contribution must be made no later than April 15, 1999… the due date of your tax return.
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The above text is an excerpt from the Motley Fool Investment Tax Guide
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