The Roth IRA is
a convenient way to give yourself access to tax-free
money when you retire. Unlike a traditional IRA, where
annual contributions are often tax-deductible and earnings
are taxed, contributions to a Roth are taxed -- but
the earnings are tax-free. If you're a smart investor
and manage your account properly, you could reap an
"The government says pay me
now or pay me later," says Bob Corcoran, vice president
of college planning at Boston-based Fidelity Investments.
"In exchange for not getting a deduction for the
Roth, come retirement your income is tax-free. That's
extremely attractive. It can lead to a higher income
stream in retirement years."
Just about any brokerage firm, bank,
credit union, mutual fund company, investment firm and
even many insurance companies will help you open a Roth
IRA. There are two ways to get a Roth started -- open
a new account and fund it with new money or convert
assets from a traditional IRA to a Roth IRA.
Remember, $4,000 is the maximum
amount the government allows anyone under 50 years old
to contribute, annually, to his or her combined IRAs.
For individuals 50 or older, the limit has been bumped
to $4,500 per year. Couples who file jointly may contribute
$4,000 each to separate Roth IRAs unless either is 50
or older. The maximum is $4,500.
As long as you have earned income equal to the amount
of your contribution and meet the income restrictions
you can open a Roth even if you have a traditional IRA
and an employer-sponsored 401(k). The maximum $4,000
contribution is allowed for individuals who file tax
returns as single and have an adjusted gross income
of less than $95,000 annually, and for couples filing
jointly whose AGI is below $150,000. Single filers whose
adjusted gross income is $110,000 or above and couples
whose joint return is $160,000 or above cannot open
If you convert a traditional IRA
to a Roth your adjusted gross income must be below $100,000
whether you're filing as an individual or as a couple
Income restrictions are one of the
few things going against Roth IRAs, says David Bendix,
a certified financial planner at Bendix Financial Group
in Garden City, N.Y.
"I'd like to see Congress open
the Roth up so you don't see income restrictions. People
are trying to take after-tax dollars and sock them away.
It's a really powerful tool."
Who should consider opening a Roth
IRA? Anyone interested in receiving a stream of tax-free
income during their retirement, says Corcoran.
"At Fidelity, we break down
the decision process into three questions. Who is eligible
based on their AGI and tax-filing status? If you're
not eligible, go with a traditional IRA. If you're eligible
for a Roth, can you deduct your contribution to a traditional
IRA? If the answer is no, then consider a Roth. What
do you expect your tax rate to be when you retire? If
it's the same or higher then consider a Roth because
you'll be converting those assets into income at that
Corcoran says Fidelity has an easy-to-use
IRA evaluator on its Web site to help investors decide
which IRA is right for them.
"What do you expect your tax
rate to be when you retire? If it's the same or higher
then consider a Roth."
for taxes in converting
Another key aspect when considering whether to convert
a traditional IRA to a Roth is how you'll pay the tax
on the earnings from the traditional IRA. The earnings
will be taxed as ordinary income. If you need to use
the IRA itself to pay the tax, it may not be a smart
idea to convert.
People who converted traditional
IRAs to Roths in 1998, the first year they were available,
were given the option to spread the tax out over four
years. That's not an option anymore but there's no rule
that says you have to convert your entire traditional
IRA at once if you want to convert. You'll have a smaller
tax bill if you convert just a quarter or one-half of
your traditional IRA each year.
Bendix says the drawback to that
is you don't have the full growing power of a Roth going
in from day one. He suggests some careful tax planning
to see if you have some capital losses that could offset
the conversion tax bill.
Despite the Roth benefit of tax-free
income, experts say many investors still want the tax
break up front.
"They're looking at one side,
not that for the next 20 to 30 years they can get tax-free
growth -- free money," says Bendix. "They're
losing focus. They need an adviser or someone to say
this is a good idea."
Good for estate-planning,
A Roth isn't just a good bet for you -- it's good for
your heirs, too. In fact, Corcoran says many investors
are using the Roth as an estate-planning tool. If you
leave a Roth to your heirs the money continues to grow
tax-free. They have to withdraw the money only as quickly
as you did. If you didn't withdraw any money, your heirs
can continue to let the money grow tax-free for many
years to come.
Updated: Dec. 30, 2005