Roth IRA

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A Roth IRA (Individual Retirement Arrangement) is a certain type of retirement plan under US law that is generally not taxed, provided certain conditions are met. The tax law of the United States allows a tax reduction on a limited amount of saving for retirement. The Roth IRA's principal difference from most other tax advantaged retirement plans is that, rather than granting a tax break for money placed into the plan, the tax break is granted on the money withdrawn from the plan during retirement.

A Roth IRA can be an individual retirement account containing investments in securities, usually common stocks and bonds, often through mutual funds (although other investments, including derivatives, notes, certificates of deposit, and real estate are possible). A Roth IRA can also be an individual retirement annuity, which is an annuity contract or an endowment contract purchased from a life insurance company. As with all IRAs, the Internal Revenue Service mandates specific eligibility and filing status requirements. A Roth IRA's main advantages are its tax structure and the additional flexibility that this tax structure provides. Also, there are fewer restrictions on the investments that can be made in the plan than many other tax advantaged plans, and this adds somewhat to the popularity, though the investment options available depend on the trustee (or the place where the plan is established).

The total contributions allowed per year to all IRAs is the lesser of one's taxable compensation (which is not the same as adjusted gross income) and the limit amounts as seen below (this total may be split up between any number of traditional and Roth IRAs. In the case of a married couple, each spouse may contribute the amount listed):

Age 49 and BelowAge 50 and Above

For example, if one is single, aged 49 or under, and earns $10,000, one can contribute a maximum of $5,000 in 2008.

* Since 2009, contribution limits have been assessed for potential increases based on inflation, though the contribution limits for 2009 through 2012 remained unchanged.


Originally called an "IRA Plus", the idea was originally proposed by Senator Bob Packwood of Oregon and Senator William Roth of Delaware in 1989.[1] The Packwood-Roth plan would have allowed individuals to invest up to $2,000 in an account with no immediate tax deductions, but the earnings could later be withdrawn tax-free at retirement.[1]

The Roth IRA was established by the Taxpayer Relief Act of 1997 (Public Law 105-34) and named for its chief legislative sponsor, Senator William Roth of Delaware.

Differences from a traditional IRA[edit]

In contrast to a traditional IRA, contributions to a Roth IRA are not tax-deductible. Withdrawals are generally tax-free, but not always and not without certain stipulations (i.e., tax free for principal withdrawals and the owner's age must be at least 59½ for tax free withdrawals on the growth portion above principal). An advantage of the Roth IRA over a traditional IRA is that there are fewer withdrawal restrictions and requirements. Transactions inside an account (including capital gains, dividends, and interest) do not incur a current tax liability.



Double taxation[edit]

Double taxation may still occur within these tax sheltered investment plans. For example, foreign dividends may be taxed at their point of origin, and the IRS does not recognize this tax as a creditable deduction. There is some controversy over whether this violates existing Joint Tax Treaties, such as the Convention Between Canada and the United States of America With Respect to Taxes on Income and on Capital.[6]

For Canadians with U.S. Roth IRAs: A new rule (2008) provides that Roth IRAs (as defined in section 408A of the U.S. Internal Revenue Code) and similar plans are considered to be pensions. Accordingly, distributions from a Roth IRA (as well as other similar plans) to a resident of Canada will generally be exempt from Canadian tax to the extent that they would have been exempt from U.S. tax if paid to a resident of the U.S. Additionally, a resident of Canada may elect to defer any taxation in Canada with respect to income accrued in a Roth IRA but not distributed by the Roth IRA, until and to the extent that a distribution is made from the Roth IRA or any plan substituted therefor. The effect of these rules is that, in most cases, no portion of the Roth IRA will be subject to taxation in Canada.

However, where an individual makes a contribution to a Roth IRA while they are a resident of Canada (other than rollover contributions from another Roth IRA), the Roth IRA will lose its status as a "pension" for purposes of the Treaty with respect to the accretions from the time such contribution is made. Income accretions from such time will be subject to tax in Canada in the year of accrual. In effect, the Roth IRA will be bifurcated into a "frozen" pension that will continue to enjoy the benefit of the exemption for pensions and a non-pension (essentially a savings account) that will not.


Income limits[edit]

Congress has limited who can contribute to a Roth IRA based upon income. A taxpayer can contribute the maximum amount listed at the top of the page only if their Modified Adjusted Gross Income (MAGI) is below a certain level (the bottom of the range shown below). Otherwise, a phase-out of allowed contributions runs proportionally throughout the MAGI ranges shown below. Once MAGI hits the top of the range, no contribution is allowed at all; however, a minimum of $200 may be contributed as long as MAGI is below the top of the range (e.g. A single 40 year old with MAGI $124,999 may still contribute $200 to a Roth IRA vs. $30). Excess Roth IRA contributions may be recharacterized into Traditional IRA contributions as long as the combined contributions do not exceed that tax year's limit. The Roth IRA MAGI phase out ranges for 2013 are:

The lower number represents the point at which the taxpayer is no longer allowed to contribute the maximum yearly contribution. The upper number is the point as of which the taxpayer is no longer allowed to contribute at all. Note that people who are married and living together, but who file separately, are only allowed to contribute a relatively small amount.

However, once a Roth IRA is established, the balance in the plan remains tax-sheltered, even if the taxpayer's income rises above the threshold. (The thresholds are just for annual eligibility to contribute, not for eligibility to maintain a Roth IRA.)

To be eligible, one must meet the earned income minimum requirement. In order to make a contribution, one must have taxable compensation (not taxable income from investments). If one makes only $2,000 in taxable compensation, one's maximum IRA contribution is $2,000.

If a taxpayer's income exceeds the income limits, they may still be able to effectively contribute by using a "backdoor" contribution process (see #Traditional IRA conversion as a workaround to Roth IRA income limits below).

Contribution limits[edit]

Contributions to both a Roth IRA and a traditional IRA are limited to the total amount allowed for either of them ($5,500 for tax year 2013 – $6,500 if over 50 years of age, i.e. if split evenly between the two, $2,750 could go to the Roth IRA, $2,750 to the traditional).[8] Generally, the contribution cannot exceed your earned income for the year in question. The one exception is for a "spousal IRA" where a contribution can be made for a spouse with little or no earned income provided the other spouse has sufficient earned income and the spouses file a joint tax return.[9]

Conversion rules[edit]

The government allows people to convert Traditional IRA funds (and some other untaxed IRA funds) to Roth IRA funds by paying income tax on any account balance being converted that has not already been taxed (e.g., the Traditional IRA balance minus any non-deductible contributions). [10]

Prior to 2010, two circumstances prohibited conversions: Modified Adjusted Gross Income exceeding $100,000 or the participant's tax filing status is Married Filing Separately. These limitations were removed as part of the Tax Increase Prevention and Reconciliation Act of 2005.

Traditional IRA conversion as a workaround to Roth IRA income limits[edit]

Regardless of income but subject to contribution limits, contributions can be made to a Traditional IRA and then converted to a Roth IRA.[11] This allows for "backdoor" contributions where individuals are able to avoid the income limitations of the Roth IRA. There is no limit to the frequency with which conversions can occur, so this process can be repeated indefinitely.

One major caveat to the entire "backdoor" Roth IRA contribution process, however, is that it only works for people who do not have any pre-tax contributed money in IRA accounts at the time of the "backdoor" conversion to Roth; conversions made when other IRA money exists are subject to pro-rata calculations and may lead to tax liabilities on the part of the converter. [10]

For example, if someone has contributed $10,000 post-tax and $30,000 pre-tax to a traditional IRA and wants to convert the post tax $10,000 into a Roth, the pro-rated amount (ratio of taxable contributions to total contributions) is taxable. In this example, $7500 of the post tax contribution is considered taxable when converting it to a Roth IRA. The pro-rata calculation is made based on all traditional IRA contributions across all the individual's traditional IRA accounts (even if they are in different institutions).


Returns of your regular contributions from your Roth IRA(s) are always withdrawn tax and penalty free.[2] Eligible (tax and penalty free) distributions of earnings must fulfill two requirements. First, the seasoning period of five years must have elapsed, and secondly a justification must exist such as retirement or disability. The simplest justification is reaching 59.5 years of age, at which point qualified withdrawals may be made in any amount on any schedule. Becoming disabled or being a "first time" home buyer can provide justification for limited qualified withdrawals. Finally, although one can take distributions from a Roth IRA under the substantially equal periodic payments (SEPP) rule without paying a 10% penalty,[12] any interest[vague] earned in the IRA will be subject to tax[13]—a substantial penalty which forfeits the primary tax benefits of the Roth IRA.--

Inherited Roth IRAs[edit]

Transfers of Roth IRAs between spouses when one spouse dies, just like other IRAs, are tax-free and the spousal beneficiary is free to make contributions and otherwise control the account. For estate tax purposes, if a Roth IRA is part of a decedent's estate that is valued under the taxable inheritance minimum, no estate tax needs to be paid. If the estate is larger than that, the Roth IRA will be taxable to beneficiaries (other than surviving spouses).

Non-spouse beneficiaries are not allowed to make additional contributions to the inherited Roth IRA, or combine it with their own Roth IRA.

In addition, the beneficiary may elect to choose from one of two methods of distribution. The first option is to receive the entire distribution by December 31 of the fifth year following the year of the IRA owner’s death. The second option is to receive portions of the IRA as distributions over the life of the beneficiary, terminating upon the death of the beneficiary and passing on to a secondary beneficiary. If the beneficiary of the Roth IRA is a Trust, the Trust must distribute the entire assets of the Roth IRA by December 31 of the fifth year following the year of the IRA owner’s death, unless there is a "Look Through" clause in which case the distributions of the Roth IRA are based on Single Life Expectancy table over the life of the beneficiary, terminating upon the death of the beneficiary. Subtract one (1) from the "Single Life Expectancy" for each successive year. The age of the beneficiary is determined on 12/31 of the first year after year the owner died.

For income tax purposes, distributions from Roth IRAs to beneficiaries are not taxable if the Roth IRA was established for at least five years before the distribution occurs.[14]

See also[edit]

Further reading[edit]

  • Bledsoe, John D. (1998). Roth to Riches: The Ordinary to Roth IRA handbook. Dallas, TX: Legacy Press. ISBN 0-9629114-1-0. OCLC 40158081. 
  • Daryanani, Gobind (1998). Roth IRA Book: An Investor's Guide: Including a Personal Interview with Senator William V. Roth, Jr. (R-De), Chairman, U.S. Senate Finance Committee. Bernardsville, NJ: Digiqual Inc. ISBN 0-9665398-1-8. OCLC 40340829. 
  • Merritt, Steve (1998). All about the New IRA, Roth, Traditional, Educational: How to Cash in on the New Tax Law Changes. Melbourne, FL: Halyard Press. ISBN 1-887063-07-2. OCLC 39363078. 
  • Slesnick, Twila; Suttle, John C. (2007). IRAs, 401(k)s, & Other Retirement Plans: Taking Your Money Out (8th ed.). Berkeley, CA: Nolo. ISBN 978-1-4133-0696-5. OCLC 85162294. 
  • Thomas, Kaye A. (2004). Fairmark Guide to the Roth IRA: Retirement Planning in Plain Language. Lisle, IL: Fairmark Press, Inc. ISBN 0-9674981-0-4. OCLC 55048948. 
  • Trock, Gary R. (1998). The Roth IRA Made Simple. Grifith, IN: Conquest Pub. ISBN 0-9666227-0-7. OCLC 40641031. 


  1. ^ a b Blustein, Paul (October 21, 1989). "Critics Call New IRA Plan a Budget Gimmick: Backers See Proposal as Ide=al Way to Spur Savings, Cut Deficit". The Washington Post. p. D12. 
  2. ^ a b "Publication 590 (2013), Individual Retirement Arrangements (IRAs)". Retrieved 2014-04-15. 
  3. ^ IRS Pub 590.
  4. ^ See Final IRS Regulations, passed December 30, 2005 not exempting Roth 401k from mandatory distributions at age 70½.
  5. ^ Internal Revenue Code Section 86(b)(2)(B)
  6. ^ [1][dead link]
  7. ^ a b Internal Revenue Service (13 May 2013). "Amount of Roth IRA Contributions That You Can Make for 2013". Retrieved 13 May 2013. 
  8. ^ "Publication 17 (2013), Your Federal Income Tax". 1943-06-30. Retrieved 2014-04-15. 
  9. ^ "Publication 590 (2013), Individual Retirement Arrangements (IRAs)". Retrieved 2014-04-15. 
  10. ^ a b Steinberg, Joseph (2012). "Warning About Roth IRA Conversions: Often Misunderstood IRS Rule Can Cost You Money and Aggravation". Forbes. Forbes. Retrieved 12 Dec 2012. 
  11. ^ Bader, Mary; Schroeder, Steve (2009). "TIPRA and the Roth IRA, New Planning Opportunity for High-Income Taxpayers". The CPA Journal. The New York State Society of CPAs. Retrieved 31 Jan 2012. 
  12. ^ IRS Publication 590, Chapter 2, "Additional Tax on Early Distributions"
  13. ^ IRS Publication 590, Chapter 2, Worksheet 2–3
  14. ^ IRS Publication 590 (2010), "What is a Qualified Distribution"

External links[edit]