I have a love-hate relationship with the Roth IRA: I love what it can do for an investor, but I hate the number of questions I get about it.
The Roth was created last summer and enacted in January. The rules are simple: Eligible savers can set aside $2,000 of after-tax money per year and have it grow tax-free forever. There are no hard-to-comprehend distribution rules, no time when the money must come out.
And eligible savers also can convert existing IRAs into the tax-free variety, though they will pay taxes now to make the change.
The investment world immediately generated dozens of Roth IRA calculators, which under almost all circumstances come to the conclusion that you’d be crazy not to have a Roth IRA.
So, when someone starts to talk to me about the Roth, I can cut to the chase by asking one of two questions:
1. What are you waiting for?
2. What haven’t you figured out about the Roth yet?
Today and again tomorrow, in an effort to help people who haven’t yet figured out the Roth, I will answer some of the most common questions about it.
Q–Am I eligible for a Roth?
A–The rules vary depending on whether you are opening a new account or converting an existing IRA. For new accounts, you are eligible to contribute the full $2,000 per year if your adjusted gross income is less than $95,000 for an individual or $150,000 for couples. Lesser annual contributions are allowed after that, until income hits $110,000 for singles and $160,000 for couples.
One other key factor: The money must be earned income, meaning that if you are not drawing a paycheck, you are out of luck. But unlike traditional IRAs, a person beyond age 70 1/2 earning wages or self-employment income can continue making contributions to a Roth account.
For rollovers, your marital status does not matter. You can convert an existing IRA into a Roth only if your adjusted gross income does not exceed $100,000. Yes, that’s a significant penalty on married folks, but you didn’t expect Congress to do everything right on this, did you?
Q–Which year’s adjusted gross income will determine my eligibility?
A–The income in the year in which you open the account determines your eligibility. If you are making the contribution or conversion now, it will be your 1998 adjusted gross income that matters. That can make things tricky, especially for anyone who was close to the limits in 1997. A good guide would be to look at your tax return for last year, which shows the adjustments the government actually makes to your salary.
As the Roth rules were written, people who make a conversion and then wind up with too much income to qualify were going to be stuck paying taxes and without the retirement savings advantages of an IRA, but the “technical corrections bill” currently going through Congress should change that.
Chances are, if you make a conversion and your income crosses the line, you will be allowed to put the money back into the traditional IRA, with no adverse tax consequences.
Q–Can I have a Roth and a traditional IRA at the same time?
A–Yes, you can mix and match IRAs. The one warning here is that you may not contribute more than $2,000 per person to any or all types of IRAs in a given year. That means you could put $1,000 into a tax-deductible IRA (assuming you are eligible) and $1,000 into a Roth, for example. And each member of a couple could have a different type of IRA for up to $2,000.
Q–Can I have a Roth and a 401(k) or other retirement plan at work?
A–Absolutely. While traditional tax-deductible IRAs were not available to people with retirement plans at work, the Roth is.
Q–When can I get my money out of a Roth?
A–You can start withdrawing both principal and interest at age 59 1/2, but one of the big advantages of the Roth over other retirement savings vehicles is that you can always get your principal out, tax-free, after five years. So if you open a Roth account now and contribute $2,000, you could pull that money out after five years–leaving the earnings in place–with no penalty.
Q–With the creation of the Roth, Congress made a provision that lets investors tap both the new accounts and traditional IRAs penalty-free to pay for “qualified higher education expenses.” What, exactly, qualifies?
A–“As far as the IRS is concerned, qualified expenses cover tuition, fees, books, supplies and equipment–in short, everything but your living costs,” says Judith McMichael, vice president for retirement services at Fidelity Investments in Boston. “But the other thing that is important to know is that those expenses can be for you, the IRA owner, or for your spouse, children and grandchildren.”
Q–What about withdrawals to pay for a first-time home purchase?
A–As stated previously, you can always get your principal out after five years in a Roth account, but the Roth also allows for the penalty-free withdrawal of $10,000 in earnings to pay for a first-home purchase. This is a one-time deal. It’s $10,000 for a lifetime, but, again, there is some freedom. The money could go to the first-home purchase of a spouse, children or grandkids.
Q–What happens if the government changes the rules?
A–The government seems to want to expand the Roth, but this is a legitimate concern. In the past, however, when the government has changed a program, it has grandfathered the people who took advantage of what was offered.
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TOMORROW: More about the Roth IRA.
