Roth Individual Retirement Account (IRA)
Since its inception in 1997, the Roth IRA (named after its sponsor, Senator William V. Roth, Jr. of Delaware) has become a hugely popular investment vehicle. Like the Traditional Individual Retirement Account, the Roth IRA is a personal savings plan that offers tax advantages to set aside money for retirement. Please see Benefits of a Self Directed Individual Retirement Account (IRA).
Investments in a Roth IRA compound tax-deferred, but what provides a unique advantage for the Roth IRA is that, once an individual has reached the age of 59½, and his/her account has existed for more than five years, all withdrawals are TAX FREE.
In this section, we will answer some frequently asked questions about the Roth IRA (also see self directed Traditional IRA vs. self directed Roth IRA). For a more detailed look into the rules and regulations for Roth IRAs, please see IRS Publication 590.
- Who is eligible for a self-directed Roth IRA?
- What are the Modified Adjusted Gross Income (MAGI) limits for a Roth IRA?
- How is Modified Adjusted Gross Income calculated?
- Do I receive a deduction for contributions made to a Roth IRA?
- How is compensation defined?
- How much can be contributed to a self-directed Roth IRA?
- Can I make contributions to a Roth IRA for my non-working spouse?
- Can I convert my Traditional IRA to a Roth IRA?
- Can rollover funds from 401(k), 403(b), SEP, SIMPLE and other retirement plans be placed into a Roth IRA?
- Do I pay taxes on earnings in my Roth IRA?
- When can I withdraw funds from my Roth IRA?
- Are there exceptions for premature distributions?
- Am I required to take distributions from my Roth IRA?
- What happens to my Roth IRA in the event of my death?
- When is the contribution deadline for funding a Roth IRA?
- How do I open a self-directed Roth IRA at Equity Trust?
- How do I transfer funds from another IRA, Qualified Plan or Tax-Sheltered Annuity to Equity Trust?
Who is eligible for a self-directed Roth IRA?
Anyone who has earned income and falls within the MAGI (Modified Adjusted Gross Income) limits can establish a Roth IRA. Unlike the Traditional IRA, the Roth IRA has no age limit for contributions, so individuals can continue to contribute as long as they like. (Note: In a Traditional IRA, an individual can only make contributions for the taxable years prior the year in which he or she reaches the age of 70 1/2.)
What are the Modified Adjusted Gross Income (MAGI) limits for a Roth IRA?
You may contribute to a Roth IRA if you have taxable compensation and your modified adjusted gross income (MAGI) is less than $114,000 ($166,000 if you are married and file a joint return, and $10,000 if you are married, lived with your spouse and file a separate return). THe amount you may contribute to a Roth IRA is gradually reduced if your modified adjusted gross income is between $99,000 - $114,000 (between $156,000 - $166,000 if you are married and file a joint return, and between $0 and $10,000 if you are married, lived with your spouse and file a separate return).
The amount you may contribute to a Roth IRA is reduced by contributions you make to a Traditional IRA. The amount you may contribute to a Roth IRA also may not exceed your taxable compensation. You may continue to make contributions to your Roth IRA after reaching age 70 1/2.
How is MAGI calculated?
Your MAGI for Roth IRA purposes is your adjusted gross income as shown on your return modified as follows:
Subtract the following: (i) Conversion income which is any income resulting from the conversion of an IRA to a Roth IRA; and (ii) RMDs from qualified retirement plans, including IRAs.
Add back the following deductions and exclusions: (i) traditional IRA deduction; (ii) student loan interest deduction; (iii) foreign earned income exclusion; (iv) foreign housing exclusion or deduction; (v) exclusion of qualified bond interest; (vi) exclusion of employer-provided adoption benefits; and (vii) domestic production activities deduction.
For more detailed instructions on how to calculate MAGI see IRS Publication 590. In addition, IRS Publication 590 includes a worksheet entitled Worksheet 2-1 that provides an easy method for individuals to figure out their MAGI for Roth IRA purposes.
Do I receive a deduction for contributions made to a Roth IRA?
No. Contributions to a Roth IRA are not tax deductible. Your contribution is made with after-tax dollars. But the advantage of the Roth IRA is that you will never pay taxes on your earnings or withdrawals ever again (as long as you have reached the age of 59 ½ and your account has been open for at least five years), and there are no mandatory withdrawal requirements, as there are for Traditional IRAs. We call this "paying taxes on the seeds, instead of on the crop."
How is compensation defined?
Compensation is defined as the wages, salaries, commissions, bonus, alimony and any other amount that the IRA owner receives for providing personal services. For individuals who are self-employed, sole proprietors and partners in a partnership, "earned income" is another term for compensation and generally includes the net income earned for the performance of personal services.
How much can be contributed to a self-directed Roth IRA?
For 2007, the maximum contribution is $4,000 and for 2008, the maximum contribution is $5,000(plus an additional $1,000 "catch-up" contribution for those individuals age 50 years or older). The general contribution limit relative to IRAs will be raised to $5,000 in 2008. After 2008, this contribution limit will be indexed to inflation and increase in $500 increments.
Contributions may be made until April 15 the immediately preceding tax year. For more information, please see IRA contribution limits. Also be sure to see how to maximize IRA contributions.
Can I make contributions to a Roth IRA for my non-working spouse?
Yes. This is referred to as a spousal IRA. The spousal IRA allows a married person to make a self directed IRA contribution for his/her spouse. In order to make contributions to a spousal IRA you must file a joint return with your spouse. Your spouse need not have earned income in order to have contributions made to a spousal IRA. A couple can contribute up to 100% of their combined earned income or $8,000, whichever is less, for the 2007 tax year (plus an extra$1,000 per person under the "catch-up" contribution rules if both individuals are age 50+, thereby bringing the possible total contribution to $10,000).
Can I convert my Traditional IRA to a Roth IRA?
Yes. But when you convert, taxes must be paid on the portion which is being converted and there are income limitations for conversion eligibility. For more information, please see self directed Roth IRA conversion at Equity Trust.
Can rollover funds from 401(k), 403(b), SEP, SIMPLE and other retirement plans be placed into a Roth IRA?
Yes. Funds from other tax-qualified retirement plans can be placed into a Roth IRA, except that amounts in a SIMPLE IRA may not be converted during the first two years after initial participation. Currently the process for accomplishing such a rollover requires a two-step process in which the funds from the tax-qualified plan are first transferred into a Traditional IRA and are then converted into a Roth IRA. However, after January 1, 2008, such a rollover can be made directly from tax-qualified plan into a Roth IRA. Whether the conversion is made through the two-step process (or is made directly to the Roth IRA for contributions starting in 2008), the transferred amount is subject to income taxation, but avoids the 10% early distribution penalty. You should consult with your plan administrator regarding the permissible withdrawal options allowed under the tax-qualified plan.
Do I pay taxes on earnings in my Roth IRA?
No. All earnings in a Roth IRA are TAX-FREE, because contributions are made with after-tax dollars. The only requirements necessary to receive these benefits are that the IRA owner must have reached the age 59 1/2 and had his or her account established for at least five (5) years.
To see for yourself the power of compound interest in a tax-free Roth IRA account, please use the Equity Trust Self-Directed IRA Wealth Calculator.
When can I withdraw funds from my Roth IRA?
Annual contributions can be taken out at any time with no tax consequences. Funds that have been converted can be taken out after the account has been established for five (5) years without penalties, regardless of age. Non-contribution funds taken out without meeting these requirements are taxable and subject to a 10% penalty.
Are there exceptions for premature distributions?
Yes. Some exceptions include:
- death;
- disability;
- education expenses;
- unreimbursed medical expenses that exceed 7.5% of your adjusted gross income;
- medical insurance premiums;
- expenses associated with buying or building first home; and
- payment of any IRS levy.
For additional information regarding the exceptions to the premature distribution rules,, please see IRS Publication 590.
Am I required to take distributions from my Roth IRA?
No. Unlike the Traditional IRA, where minimum distributions are required beginning at the age of 70 1/2, there are no mandatory distribution requirements for the Roth IRA.
What happens to my Roth IRA in the event of my death?
Your named beneficiary(ies) will receive the entire proceeds of your Roth IRA. The manner in which your beneficiary(ies) will receive the funds is determined by the election made by your beneficiary within the guidelines of the law.
When is the contribution deadline for funding a Roth IRA?
Roth IRAs for the taxable year can be opened and/or funded any time between January 1 and the date your tax return is due for the year, excluding extensions. The due date is always April 15 of the following year.
How do I open a self directed Roth IRA at Equity Trust?
See instructions on how to open a self-directed Roth IRA at Equity Trust.
How do I transfer funds from another IRA, Qualified Plan or Tax-Sheltered Annuity to Equity Trust?
See instructions on how to transfer and rollover IRAs into an Equity Trust IRA.