New Roth IRA Rules

February 1, 2010

The Roth IRA was introduced as a retirement investment option back in 2007. The New Year, 2010, has brought changes to the Roth IRA rules that are making this retirement investment vehicle better for some investors than ever before. In order to fully understand how a Roth IRA can be more beneficial than a traditional IRA you first have to understand the logistics of each retirement account option.

Traditional IRAs

Traditional IRAs allow account holders to deposit up to $6,000 per year if you’re over 50 years old and up to $5,000 per year for those younger than 50. Whether or not the contributions you make to a traditional IRA are tax deductible depends on the amount of your income and if you have another retirement account such as a 401(k) through an employer.

If you withdraw money from a traditional IRA account before you turn 59½ you are typically charged a 10% early withdrawal fee. Otherwise, you can begin taking distributions from the account when you turn 70½ and pay income tax on the amount of the withdrawal at your current tax rate.

The good news for retirement account holders that are 70 or older is the federal government is offering a temporary reprieve. Minimum distributions from tax-deferred retirement accounts (IRAs, employer sponsored retirement plans, inherited IRAs and inherited Roth IRAs) are not required this year, which helps to offset some of the major losses these accounts saw because of the floundering economy.

Roth IRAs

A Roth IRA works a little differently than a traditional IRA. The first difference is that you pay income taxes at your current income tax rate when you make your contributions to the account. The other difference is that you are not taxed again when you make your withdrawals. You are also not required to start making your withdrawals at the age of 70½ as you are with a traditional IRA. If you make early withdrawals, as long as you are at least 59½, you do not pay a tax penalty for early withdrawals.

The downside of a Roth IRA was that if you have a 401(k) or IRA Rollover and your annual income exceeds $100,000 per year, then you are not eligible for a Roth IRA.

As of January 1st 2010 this changes. Households converting an existing traditional IRA to a Roth IRA account can do so because there is no longer an income restriction. The minor setback of the conversion is that you pay income taxes on the amount of money you convert at your current income tax rate.

Roth IRA conversions that take place in 2010 allows you to deduct half of the income when you file your 2011 tax returns and the other half of the income when you file your 2012 tax returns.

Questions to Answer to See if a Roth IRA is Right for You

  • Will my tax rate change in the future? If you expect your tax rate to decrease then paying to convert to a Roth IRA may not make sense when you can pay less money on your income later in life. This is especially true as you near retirement and withdrawal age.

On the other hand, if you have significant assets, it may be worth paying for the conversion because financial experts predict tax rates will increase in the future.

  • Do I have the money to pay for the tax conversion? If you do not have the cash to pay for the Roth conversion, then it doesn’t make sense to do so. If you have to use the money in your retirement account to pay for the conversion, you will be penalized the 10% early withdrawal fee and lose the tax-free growth status on the money in the account.

You can convert a portion of the money into a Roth IRA, which should be the portion you can afford to pay the taxes on, and convert the rest into a Roth IRA in the future when you can afford to pay the taxes on this amount.

According to the results of a recent survey conducted by USAA, only nine percent of those surveyed with household incomes of more than $100,000 and 27 percent of all those surveyed (who own an IRA) plan on turning their tax-deferred savings into tax-free retirement income. This means for the most part that the new Roth conversion rules may go to waste for investors that would benefit most.


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Kristie Lorette is a personal finance writer who spent over eight years working in the real estate, mortgage and credit industries.

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5 Responses to New Roth IRA Rules

  • dave

    Also, the rules allow you to spread out the Roth conversion amount over the next two years, but watch out! The tax rates on income go up in 2011, so it may not be better to do this.

    You are right Mel, converting may not work for everybody, there’s way too much hype about the 2010 conversion rules, but not everybody knows how it could affect them.

  • Mel

    Also, the rules allow you to spread out the Roth conversion amount over the next two years, but watch out! The tax rates on income go up in 2011, so it may not be better to do this.

  • Daddy Paul

    The rules for this year make conversion a difficult decision. I rolled some of my traditional money over in March 2009 and March 2003 when the market was way down and I had no additional money to invest so I used Uncle Sam to leverage the money. And yes I got lucky.


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