Roth 401(k) and Roth IRAs can be powerful tools for saving for your retirement. The Roth IRA was created in 1996 and the Roth 401(k) in 2006. They both allow you to save for retirement and enjoy tax-free withdrawals. The Roth IRA has income limitations for contributions and conversions. These limitations do not apply to the Roth 401(k). In 2010, a one-time window allows increased access to Roth conversions. Details on this window are below.
Unlike traditional IRAs, the Roth IRA provides no federal income tax deduction for contributions. However, it does provide benefits not found in any other retirement plan - tax-free withdrawal of all earnings and principal. Another difference is there is no age limit for Roth IRA contributions. There are income or compensation limits that will determine how much you can contribute to a Roth IRA. In 2008, you are eligible to contribute to a Roth IRA as long as your adjusted gross income (AGI) meets the following requirements:
- For married couples filing jointly, your AGI must be less than $166,000.
- For married couples filing separately the AGI limit is $10,000.
- If your filing status is Single, Head of Household or Married Filing Separately (and you do not live with your spouse in that tax year), then the AGI limit is $114,000.
In 2008, you can contribute up to $5,000 or $6,000 if you are 50 or older. The Roth IRA also allows for a catch-up contribution for those individuals that will be 50 years old any time during the year of contribution. For 2009, the contribution limit will be indexed to inflation. The actual dollar limit announcement will be in late 2008 for 2009.
Your spouse can also contribute to a Roth IRA as long as the above income limits are not exceeded. You can make your contribution to a Roth IRA anytime during the year up until the due date for your return for that tax year - which is usually around April 15th.
2008 Roth IRA Income Limits
Filing Status Full Contribution Contribution Phased Out No Contributions
Single Filers $99,000 $99,000 - $114,000 $114,000 or more
Joint filers $156,000 $156,000 - $166,000 $166,000 or more
Another nice feature of the Roth IRA is related to minimum distributions. Unlike other retirement vehicles, you are not required to take distributions from your Roth IRA at any age.
The original 1997 law that created the Roth IRA limited who could convert an existing IRA to those with an AGI of less than $100,000. However, in May of 2006 President Bush signed a $70 billion tax cut provision that changed the eligibility rules for Roth IRA conversions. Starting in 2010, taxpayers with modified AGI of more than $100,000 can convert a traditional IRA to a Roth IRA. This change applies for one year only - 2010 - and the income taxes due on conversions can be spread over two years. The 2010 conversion amount may be included as taxable income in 2011 and 2012 - helping to spread out the tax bite. Conversions in subsequent years will follow the current rules. There is no change to the rules for funding a Roth IRA, but anyone will be able to convert to a Roth IRA for one year.
Even if your income is too high to make a Roth IRA contribution this year, by making a traditional IRA contribution this year and next you will be able to convert this balance and any other traditional IRAs in 2010 and take advantage of spreading the tax bill over two years.
Roth 401(k)
One of the great things about the Roth 401(k) is there are no income limits to contribute. The Roth 401(k) provision was part of the Economic Growth and Tax Relief Reconciliation Act that became effective in 2006. In 2008, Roth 401(k) contributions remained the same as they were in 2007 -$15,500. In addition, for those age 50 years and older the catch-up contribution raises the limit to $20,500.
Another benefit is you can rollover a Roth 401(k) into to a Roth IRA when you terminate employment or at retirement. This loophole allows you to get around the minimum distribution requirement at age 70 1/2 - just roll the Roth 401(k) into a Roth IRA (which has no minimum distribution requirement). Keep in mind the contribution decision is sometimes based on what you think your tax bracket or tax rate will be in the future. If you expect your tax bracket will be higher or the same as it is now when you are retired, then you are probably better off with a Roth 401(k). If your tax bracket will be lower in retirement, then the tax-free withdrawal advantage of the Roth 401(k) plan diminishes.
We invite additional questions about these features and how they relate to your 401(k) plan. Please contact Andrew Sweeny Jr. or Scott Thole at 513.745.0707.
