Don’t Overlook Roth IRA Benefits

When it comes to building a retirement net egg, the Roth IRA is gaining in popularity and for good reason, says the New York State Society of CPAs. The Roth IRA offers a number of benefits, including tax-free qualified withdrawals at retirement and the ability to take certain early distributions without penalty. Here is an overview of the basic rules governing the Roth IRA, its key benefits, and how it compares with traditional IRAs.

The basics

The maximum annual contribution is the same for both traditional and Roth IRAs. For 2006, you may contribute $4,000 to an IRA. Taxpayers age 50 or older by the end of 2006 may make an additional “catch up” contribution of $1,000 for 2006.

Unlike traditional IRAs, Roth IRA contributions are not tax deductible. While this may limit the Roth IRA’s short-term income tax benefits, taxpayers would be wise to consider the financial impact of the Roth IRA’s tax-free withdrawals.

As with deductible traditional IRAs, you must meet certain income requirements to qualify for a Roth IRA. The modified adjusted gross income (MAGI) for a full contribution for single filers may not exceed $95,000 and $150,000 for married taxpayers filing jointly. The amount you can contribute is reduced gradually and then completely eliminated when your MAGI exceeds $110,000 if you file as single or $160,000 for joint filers. However, unlike traditional IRAs, participating in a retirement plan offered by your employer will not affect your eligibility to contribute to a Roth IRA.

Benefit 1: Roth IRA Distributions may be tax-free

For most taxpayers, the greatest benefit of a Roth IRA is its tax-free distributions. Distributions, including earnings, are tax free when you meet two key requirements. First, the Roth IRA must be in existence for more than five years. This does not mean that each contribution must remain in the account for five years before you can withdraw the earnings tax-free. It means that five years must pass from the first day of the first taxable year from which any Roth contribution was made. If you start a Roth IRA in 2006, your distributions will be tax-free beginning in 2011. Second, one of the following conditions must be met: you are age 59? or older at the time of the distribution; you are disabled; the distribution is used to pay up to $10,000 of qualifying first-time home buyer expenses; or you are a beneficiary receiving distributions following the death of the account holder.

Benefit 2. You can contribute to a Roth IRA at any age

People with traditional IRAs cannot make deposits once they reach 70? years of age. As long as you have earned income (and meet the modified adjusted gross income requirements), you may contribute to a Roth IRA at any age.

Benefit 3: No mandatory minimum distribution requirements

With a traditional IRA, you must start taking money out of your IRA by April 1 of the year following the year you reach age 70?, whether or not you need the money. When you have a Roth IRA, you’re free to keep the money invested where it can continue to grow tax-free, until you need it.
At your death, any funds remaining in your IRA go to your beneficiaries. Your beneficiaries will be subject to a minimum distribution requirement.

Benefit 4: Contributions may be withdrawn without taxes or penalties

You can withdraw your Roth IRA contributions at any time for any reason without paying income taxes or penalties on the amount of your contributions. However, unless you are age 59? or meet certain limited exceptions, early withdrawals of earnings may be subject to taxes and penalties. Roth IRA distributions are treated as being made first from contributions and then from earnings.

Consult with a CPA

Like any financial decision, the decision to open a Roth IRA requires careful consideration. A CPA can help you determine whether a Roth IRA fits your financial situation. Also ask about new rules for converting from a traditional to a Roth IRA.