Individual Retirement Decisions

Reprinted from PN March 2011

Not many investments provide tax-free growth, but the Roth IRA is one of them.

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The Taxpayer Relief Act of 1997 introduced a new Individual Retirement Account (IRA) called the Roth IRA. The primary inducement to make contributions to the new Roth IRA is that distributions are tax-free if certain conditions are met. This is a way for those of us who are disabled, and people who are not, to put money away long term and withdraw the growth (appreciation, dividends, and interest) tax-free as long as certain conditions are met. Not many investments provide tax-free growth, but this is one of them. One drawback to the Roth IRA is that contributions to the account are never deductible.  

Passage of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) in 2001 provided for increased contributions going forward. For 2010, an individual may contribute up to $5,000 to a Roth IRA (less any contribution made to a traditional IRA). In addition, EGTRRA established a catch-up provision: People who became age 50 or over during the tax year may contribute an additional $1,000.

Contributions to Roth IRAs are not deductible and must be in cash when made. In addition, unlike regular IRAs, there is no age restriction on making contributions. The AGI threshold for contributing to a Roth IRA is $105,000 for single individuals and $167,000 for married people filing a joint return. For single filers, the allowed contribution is phased out for AGI between $105,000 and $120,000. For married taxpayers, the allowed contribution is reduced proportionately if AGI is between $167,000 and $177,000. No Roth IRA contributions are allowed if someone is married and files separately.

The earnings attributable to contributions accumulate on a tax-deferred basis and become tax-free and penalty free upon withdrawal—provided the Roth IRA has been in effect for at least five years and the taxpayer: 

- Has attained age 59½

- Dies or becomes disabled, or

- Is a “qualified first-time home buyer” using the distribution to purchase a primary residence

Distributions from a Roth IRA that has been in effect for at least five years and are taken for any of the above reasons are known as “qualified distributions.” They are not includible in taxable income.  

Now for the tricky part: Distributions taken from Roth IRAs before any of the events specified above are met are deemed “nonqualified distributions.” They will be taxable and potentially exposed to the 10% penalty to the extent the distribution includes earnings.

Unlike traditional IRAs, there is no requirement to begin distributions from a Roth IRA at age 70½. Individuals can continue to defer tax on Roth IRA earnings for their entire lifetime. The traditional IRA required minimum distribution rules do apply to the beneficiary of a Roth IRA following the death of the Roth IRA participant. Thus, a beneficiary can continue to defer tax on Roth IRA earnings but is subject to minimum distribution requirements.

A traditional IRA may roll over (or simply convert) all or part of the assets into a Roth  IRA. Withdrawals from a traditional IRA that are so converted are not subject to the 10% penalty tax. However, the full amount of the conversion may be subject to taxation.

In deciding whether to make contributions to a traditional or a Roth IRA, taxpayers should take into account a number of factors, including:

- Eligibility to make contributions

- Number of years to accumulate earnings

- The time projected to begin distributions

- Current versus future tax brackets

Taxpayers must consider whether the current deduction of contributions to a traditional IRA is more valuable than the future recovery of earnings tax-free.

Of course, this brief article is no substitute for a careful examination of all the advantages and disadvantages of this matter in light of your unique personal financial circumstances. Before implementing a financial-planning strategy, consult your financial advisor and tax professional.

This information was developed by Dan Jones of Raymond James & Associates, Inc., and by Forefield, Inc., an independent third party. It is general in nature, is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or a solicitation to buy or sell any security. Investments and strategies mentioned may not be suitable for all investors. Past performance may not be indicative of future results. Raymond James & Associates, Inc., member New York Stock Exchange/SIPC, does not provide advice on tax, legal, or mortgage issues. Discuss these matters with an appropriate professional. 

Contact: / DanJones / 800-657-8969 / Daniel C. Jones,
Branch Manager, V.P. Investments, Raymond James & Associates, Inc., 1095 Rydal Road,
Suite 240,
Rydal, PA 19046.


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