The beginning of tax season is always a good time to review the rules applicable to IRAs. Early 2010 is an especially good time because for the first time anyone can change their Traditional IRA to a Roth IRA. IRAs are tax advantaged personal retirement vehicles legislated into existence several decades ago. Over the years, several different types have evolved. The original IRA is now termed “Traditional IRA” to which an individual may make either a deductible or non deductible contribution. Contributions to a “Roth IRA” are never deductible. The third type is a “Simplified Employee Pension or SEP” which is nothing more than an individual’s Traditional IRA to which the individual’s employer makes contributions on behalf of such individual.
There are several rules applicable to both Traditional and Roth IRAs. The maximum contribution that can be made to all IRAs is $5,000 for 2009 and 2010 ($6,000 if the individual is at least 50 years old). A contribution for 2009 can be made up to 4/15/2010. An individual (or spouse in certain cases) must have earned income or alimony at least equal to the contribution. Finally, deductible contributions to a Traditional IRA and contributions to a Roth can be limited or eliminated if certain income limitations are exceeded.
Most people make contributions to Traditional IRAs only if tax deductible. Earnings and appreciation are tax deferred until distributed at which point the full amount of any distribution is taxed at ordinary income tax rates. If non deductible contributions have been made, a prorated portion of any distribution is a tax free return of after tax dollars. One cannot contribute to a Traditional IRA once they reach 701/2 years of age. Distributions must begin the year after attaining age 70 1/2 (“Required Minimum Distributions or RMDs”). Distributions before age 59 1/2 are subject to a 10% premature distribution penalty, with certain exceptions.
Contributions to a Roth IRA are never tax deductible. Distributions of contributions, earnings and appreciation are tax free if made after the 5th anniversary of opening a Roth account when the individual either attains age 591/2 or certain other conditions are met. Contributions to a Roth can be made after reaching age 70 1/2. There is no Required Minimum Distribution for the owner of a Roth and generally no 10% premature distribution penalty.
As previously mentioned, deductible contributions to a Traditional IRA and contributions to a Roth IRA may be limited by income (“Modified Adjusted Gross Income” or “MAGI”). The amount of deductible contributions for unmarried individuals participating in their employer’s retirement plan begins to phase out for 2009 when MAGI equals $55,000 and is completely phased out at $65,000 ($56,000 and $66,000 respectively for 2010). For married individuals filing a joint return, if both spouses are covered by an employer plan, the deductible contribution for both 2009 and 2010 begins to phase out when MAGI equals $89,000 and is completely phased out at $99,000. If your spouse is covered but you are not, your deduction begins to phase out at $166,000 and is eliminated at $176,000 for 2009 ($167,000 and $177,000 respectively for 2010). For 2009 and 2010 the deductible contribution for married taxpayers filing separately begins to phase out at $0 and is totally phased out at $10,000 of MAGI if either the taxpayer or in some cases their spouse is a participant in an employer plan for both 2009 and 2010. Non-deductible contributions to a Traditional IRA are not limited by income.
The ability to make a contribution to a Roth IRA is phased out when MAGI exceeds certain levels irrespective of active participation in an employer retirement plan. For unmarried taxpayers, this ability begins to phase out when MAGI equals $105,000 and is completely phased out at $120,000 for both 2009 and 2010. For married taxpayers filing a joint return, the phase out amounts are $166,000 and $176,000 for 2009 ($167,000 and $177,000 respectively for 2010). The phases out amounts are $0 and $10,000 for married taxpayers filing separately for 2009 and 2010.
Many taxpayers think a Roth IRA would be favorable to a Traditional IRA considering the inevitable increase in income tax rates. Conversion to a Roth was previously available only to those with income less than $100,000. The tax law offers a window of opportunity to anyone, regardless of income, to convert to a Roth beginning in 2010. The next post will examine this opportunity.
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