Roth IRAs – Making A Good Thing Better

1. Roth IRAs are funded with after-tax income, so there is no current deduction for annual contributions. However, earnings are tax-free upon withdrawal. In contrast, traditional IRAs are funded with pre-tax income, so taxes on earnings generally must be paid upon withdrawal at ordinary income tax rates.
2. There are no required minimum distributions (RMDs) with Roth IRAs. This means you don’t have to start taking money out at age 70½ (like you do with a traditional IRA) if you don’t need it, and can even bequeath the money to your heirs if you choose.
3. Roth IRA contributions (but not earnings) can be withdrawn tax-free and without penalty at any age. In contrast, withdrawals from a traditional IRA before age 59½ are usually subject to a 10% early distribution penalty and taxation at ordinary income tax rates.

This third provision can make Roth IRAs an extremely flexible savings and investment tool. For example, many people use Roth IRAs as both college and retirement savings tools—in effect, killing two investment “birds” with one stone!

Annual Contribution Limits

The annual contribution limit for Roth IRAs is the same as it is for traditional IRAs: $5,000 a year (or $416 a month), or $6,000 a year (or $500 a month) if you’re age 50 or over.

Both you and your spouse can each establish separate Roth IRAs and contribute up to this amount. Important note: These annual contribution limits apply to Roth and traditional IRAs combined. In other words, if you’re 50 years old, you could contribute $3,000 to a Roth IRA and $3,000 to a traditional IRA in one year, but not $6,000 to each.

Unfortunately, not everyone is permitted to open and contribute to a Roth IRA. Eligibility phases out above certain modified adjusted gross income (MAGI) limits:

• If your MAGI is between $110,000-$125,000 (if you’re single) or $173,000-$183,000 (if you’re a married couple filing jointly) in 2012, you can make a partial Roth IRA contribution.
• If your MAGI is $125,000 (if you’re single) or $183,000 (if you’re a married couple filing jointly) or more in 2012, you can’t open or contribute to a Roth IRA.

It’s Not Too Late for 2011

Note that Roth IRA contributions can be made up until your tax-filing deadline (not including extensions). Therefore, you likely have until this April 17 to make a contribution for tax year 2011, assuming you meet the criteria noted above.

“Sometimes, it can be difficult to decide which IRA makes the most sense for you. Your investment counselor can help you weigh the pros and cons of traditional and Roth IRAs and make the best decision based on your individual circumstances and goals,” says David Lerner, founder of David Lerner Associates.