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Is a Roth IRA Right for You?

Should you contribute to a Roth IRA (individual retirement account) or a traditional IRA for the 2005 tax year? There is no definitive answer. However, for many high-income taxpayers, the Roth IRA can produce better results over the long haul.

Basic premise: Unlike a traditional IRA, contributions to a Roth IRA are never tax deductible. However, qualified distributions from a Roth IRA are 100% tax-free, so you benefit on the back end.

A qualified distribution is made from a Roth IRA in existence for at least five years and paid:

*After reaching age 59½;

*On account of death or disability;

*For first-time homebuyer expenses (up to a lifetime limit of $10,000)

For the 2005 tax year, an eligible individual can make a contribution to a Roth IRA of up to $4,000 ($4,500 if he or she is age 50 or over). This assumes you had at least that amount of annual compensation. The maximum contribution amount is reduced by any contributions to traditional IRAs (but not contributions to a SIMPLE [savings incentive match plan for employees] IRA or a SEP [simplified employee pension] IRA).

However, the allowable contribution to a Roth IRA is phased out for certain high-income taxpayers. For 2005, the phase-out occurs between $150,000 and $160,000 of adjusted gross income (AGI) for joint filers; $95,000 and $110,000 for single filers. As with a traditional IRA, you have until the tax return due date for your 2005 return—generally, April 17, 2006—to make a contribution for the 2005 tax year.

Roth IRA conversions: You can convert a traditional IRA into a Roth IRA in any tax year in which your AGI does not exceed $100,000. For this purpose, required minimum distributions from your traditional IRA do not count. For instance, if you are retired with an AGI of $95,000 this year, you can convert to a Roth IRA, even if you are required to take a $10,000 IRA distribution.

The income resulting from the conversion—in other words, the amount representing deductible contributions and earnings—is taxable in the year of the conversion. However, you do not have to pay the 10% penalty for early withdrawals if you are under age 59½.

Finally, if it meets your needs, you can effectively “undo” a conversion to a Roth IRA by recharacterizing your Roth IRA back to a traditional IRA. In effect, it is like you never made the conversion in the first place. You have until the tax return due date for the year of the conversion, plus extensions, to recharacterize your IRA.

Best of all, you can eliminate a sizeable tax liability if the assets have declined since you converted them.

Example: Mr. Smith is in the 25% tax bracket. In 2005, he converted taxable IRA assets of $100,000 to a Roth IRA. So he paid $25,000 at the time of the conversion. But now the assets are worth only $60,000. If Mr. Smith recharacterizes the Roth IRA, the $25,000 tax bill is wiped off the books. Furthermore, if he converts the IRA back into a Roth IRA at a future date when the assets are still worth $60,000, he pays tax of $15,000—a $10,000 tax savings.

Obviously, everyone's situation is different. It is recommended that you consult with a professional adviser before you make any drastic moves.

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	[ return to list ] Is a Roth IRA Right for You? Should you contribute to a Roth IRA (individual retirement account) or a traditional IRA for the 2005 tax year? There is no definitive answer. However, for many high-income taxpayers, the Roth IRA can produce better results over the long haul. Basic premise: Unlike a traditional IRA, contributions to a Roth IRA are never tax deductible. However, qualified distributions from a Roth IRA are 100% tax-free, so you benefit on the back end. A qualified distribution is made from a Roth IRA in existence for at least five years and paid: After reaching age 59½; On account of death or disability; *For first-time homebuyer expenses (up to a lifetime limit of $10,000) For the 2005 tax year, an eligible individual can make a contribution to a Roth IRA of up to $4,000 ($4,500 if he or she is age 50 or over). This assumes you had at least that amount of annual compensation. The maximum contribution amount is reduced by any contributions to traditional IRAs (but not contributions to a SIMPLE [savings incentive match plan for employees] IRA or a SEP [simplified employee pension] IRA). However, the allowable contribution to a Roth IRA is phased out for certain high-income taxpayers. For 2005, the phase-out occurs between $150,000 and $160,000 of adjusted gross income (AGI) for joint filers; $95,000 and $110,000 for single filers. As with a traditional IRA, you have until the tax return due date for your 2005 return—generally, April 17, 2006—to make a contribution for the 2005 tax year. Roth IRA conversions: You can convert a traditional IRA into a Roth IRA in any tax year in which your AGI does not exceed $100,000. For this purpose, required minimum distributions from your traditional IRA do not count. For instance, if you are retired with an AGI of $95,000 this year, you can convert to a Roth IRA, even if you are required to take a $10,000 IRA distribution. The income resulting from the conversion—in other words, the amount representing deductible contributions and earnings—is taxable in the year of the conversion. However, you do not have to pay the 10% penalty for early withdrawals if you are under age 59½. Finally, if it meets your needs, you can effectively “undo” a conversion to a Roth IRA by recharacterizing your Roth IRA back to a traditional IRA. In effect, it is like you never made the conversion in the first place. You have until the tax return due date for the year of the conversion, plus extensions, to recharacterize your IRA. Best of all, you can eliminate a sizeable tax liability if the assets have declined since you converted them. Example: Mr. Smith is in the 25% tax bracket. In 2005, he converted taxable IRA assets of $100,000 to a Roth IRA. So he paid $25,000 at the time of the conversion. But now the assets are worth only $60,000. If Mr. Smith recharacterizes the Roth IRA, the $25,000 tax bill is wiped off the books. Furthermore, if he converts the IRA back into a Roth IRA at a future date when the assets are still worth $60,000, he pays tax of $15,000—a $10,000 tax savings. Obviously, everyone's situation is different. It is recommended that you consult with a professional adviser before you make any drastic moves. [ return to list ]
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