When deciding between a Roth IRA vs Traditional IRA, you should first determine whether you think your taxes will be higher or lower in retirement (or what your expected income will be upon retirement).
If you believe your tax rate will go down in retirement, you’re probably better off contributing to a Traditional IRA. If, on the other hand, you think you’ll be in a higher tax bracket, converting to a Roth now may make more sense. In light of current huge budget deficits, chances are future tax rates will be higher than current ones.
Roth IRA Contribution Rules
Your eligibility to contribute to the Roth IRA is determined by your Adjusted Gross Income (AGI) and tax filing status. Here are the guidelines
Single Filer
- AGI up to $105,000 to qualify for a full contribution; *
- $105,000-$120,000 to be eligible for a partial contribution.
- $120,000 or more you’re not allowed to contribute to the Roth IRA.
Joint Filer
- AGI up to $167,000 to qualify for a full contribution;
- $167,000-$177,000 to be eligible for a partial contribution.
- $177,00 or more you’re not allowed to contribute to the Roth IRA.
Update: * The new Roth IRA conversion rules (for 2010) have lifted the previous $100,000 Modified Adjusted Gross Income for conversions from Traditional IRA to Roth, making a conversion possible for even higher income earners. Previously only singles and married couples earning less than $100,000 were able to convert.
Now there is no income limits for converting a Traditional IRA to a Roth IRA. And if the conversion is done in 2010, you can defer the taxes until 2011 and 2012. You can claim 50% of the taxes on the conversion in 2011 and the other 50% in 2012. Note that this rule is only good for the 2010 tax year.
If you’re young and need a reason to invest in a Roth IRA, here’s a great article on why you need a Roth IRA by Erin Burt, Contributing Editor, Kiplinger.com.
Roth IRA Distribution Rules
Assuming your first contribution to Roth was at least 5 years before your first withdrawal (5 years holding period), Roth IRA distributions are completely tax and penalty free after you reach the age of 59 ½. The term distribution is essentially the same as “withdrawal” in this case, which occurs when you take money out of your retirement account.
Early withdrawals are subject to a 10% early withdrawal penalty, however, there are some exceptions to this rule. If you become disabled or use the proceeds to purchase your first home or pay qualified educational expenses, you are generally exempt from the 10% early withdrawal penalty.
However, unlike Traditional IRA, you’re allowed to withdraw your contributions at any time, tax free and without penalty while the same rule does not apply to earnings and dividends from your investment.
For example if your Roth IRA balance is $5,000 – made up of $3,500 in contributions and $1,500 in earnings, you would be permitted to withdraw ONLY $3,500 at any time without triggering any penalties or fees.
With greater tax advantage, Roth IRA is probably one of the best of 401k rollover options to maximize your investment dollars, but before you make any decision, you need to consider one fundamental issue – how close you are to retirement.
It’s pretty obvious that the older you are, the less sense it makes to rollover to Roth IRA. For someone in their 50s, he’ll have less time to make up for what he lost in taxes on the conversion. Make sense?
Related 401(k) Articles:
- 401(k) Rollover to Roth IRA Suppose you have a 401k plan in your old employer’s company, you wonder what you...
- Is a Roth Conversion Right for You? Kim Lankford from Kiplinger explains why 2010 is the year of the Roth for the...
- What is a 401k Plan? If you’re an employee, chances are you already know what a 401k plan is, but...
- Automatic 401(k) Enrollment vs Traditional 401(k) If you’re an employee, chances are you already know what a 401k plan is and...
2010 Contribution Limits
The 401(k) contribution limit for is $16,500 for those under 50 years old. For anyone between the ages of 50 and 59 ½ years old you also have the option of contributing an additional $5,500 as a catch-up contribution.The IRA contribution limit for is $5,000 for those under 50 years old, with a $1,000 catch-up contribution option for those between 50 and 59 ½ years old.