The Roth IRA has become one of the most talked about financial products on the market. So much so, that the word “Roth” has come to be synonymous with retirement funds, even though there are other types of IRA’s out there, including things like the traditional IRA, the SIMPLE IRA, and the education IRA.

All of these have their benefits and drawbacks. Some of them are relatively new to the IRA market. The SIMPLE IRA for instance allows an employer to fund an IRA for himself or herself and his or her employees, but also allows employees to contribute up to $11,500 each year into an IRA – even more if you’re over the age of 50.

But with all this talk of different kinds of IRAs, the Roth still enjoys the greatest reputation as a worthwhile retirement investment. And for good reason. The down side is that contributions are not tax deductible when they are put into the Roth, but the upsides are many. Roth IRA earnings accumulate tax free, and are tax free even upon distribution. The waiting period for withdrawing funds is also relatively short. To withdraw from a Roth IRA without penalty, the waiting period is only 5 years. Of course, it’s advised to wait as long as possible before withdrawing funds, but should an emergency occur it’s good to know that the money is available.

So What’s the Best Bank to Invest In?

It’s important to realize that there’s no one right answer for everyone. Additionally, it’s a good idea not to spend too much time hemming and hawing about the right bank to invest with. What’s more important is to start your IRA soon, to maximize the amount of time your money will have to build interest and value.

Considerations for Your Bank Roth IRA

That said, there are a few things you’ll want to consider. First, consider the level of customer service you’re going to need. If you’re new to investing, you’ll need a little more hand holding along the way. Investing with a bank that offers some help for young investors is probably a sound idea for the person in this situation. Call a few banks and have quick conversations about their offerings. See who you like the most, and who has the best customer service claim.

Also look for a bank that has a lot of free advice out there for managing your money. Check for banks that have active blogs or customer communities. Talk to these people and check on money management conversations. You want a partner that will help you leave your IRA in place for as long as possible so it can gain interest and help fund a comfortable retirement.

Look at factors like Minimum Deposit, Stock Trades Commission, Options Trades Commission, Margin Rates and inactivity Fees. Some banks may seem good on the surface, but then hit you with fee after fee for things that seem pretty silly. Customer service is important, but if you get nickel and dimed into paying for it, the cost versus the benefit may begin to shift.

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Upon the death of a loved one, you may have inherited a Roth IRA as a beneficiary of the estate. There are different rules that apply to a Roth IRA when received as inheritance. First, the federal estate tax will apply to assets owned in a Roth IRA. Additionally, if a Roth IRA was set up in less than five years before a party dies, beneficiaries may have to pay the taxes on earning if funds are withdrawn early.

Tax Free Inheritance With the Roth

Understanding Estate Taxes

Roth IRAs are not exempt from estate tax. If, upon your death, you own a Roth IRA and it is bequeathed to a beneficiary other than your spouse, the Roth account will be included in your taxable estate. The federal estate tax is applicable to assets you have at death if the taxable estate is more than the unused part of the unified credit amount.

There is a benefit for estate taxes with the Roth IRA since the account contains after tax funds. The total size of your estate will be reduced by the amount of taxes you have paid on the funds so you will have a smaller taxable estate if if the value of the estate being passed on is greater. Since you have already paid the income tax on the Roth account, your beneficiaries will save. Some people are misled in thinking the savings comes from a special estate tax rule.

Understanding Income Tax on Inherited Roth IRA

The way a Roth IRA handles income tax is basically the same as before a death. However, there are three exceptions to this scenario including:

Beneficiaries of the account may be required to take distributions as per the following rules:

Beneficiaries Other than Spouse

If you are the beneficiary of a Roth IRA account and are not the spouse of the decedent you will not be allowed to make contributions or use the inherited Roth IRA account in combination with any accounts you have already established.

Distribution rules for non-spouse inheritance of a Roth IRA account will be dependent on when the death occurred in relation to the start date for distributions. Distributions for a non-spouse beneficiary must meet one of the following requirements:

The owner of the Roth account may have listed specific applicable rules for the Roth IRA account but typically the decision is left up to those inheriting the account.

Beneficiaries of Spouse

If a Roth IRA is inherited from your own spouse, you have the option to continue using the Roth account as your own. You will be allowed to make regular contributions or conversion contributions to the account. Additionally, distribution requirements for non-spouse beneficiaries do not apply if the account is used as your own fund. The money can be left in the IRA account for as long as you choose but you will not be able to withdraw tax-free earnings without penalty until the age of 59 ½ has been reached.

The Roth IRA (individual retirement account) is an excellent tool to invest and save money toward retirement. Similar in some ways to the traditional IRA and sharing many of its features, the Roth does still offer some unique benefits not found elsewhere in the world of retirement accounts. Many of the benefits enjoyed by the owners of Roth IRA accounts are in the way the account is distributed. Here we take a look at the common questions regarding distribution rules for the Roth IRA.

photo credit: killthebird

What is a distribution?

Before delving into distribution rules, it is important to understand what we are talking about when we use the term “distribution”. Simply put, a distribution from your Roth IRA is the same as a withdrawal. In other words whenever you take money from the account you are receiving a distribution. A qualified distribution from your account is one that is not subject to taxes or penalties.

It is important to remember that there are many caveats to these rules. For example if you have converted another type of retirement plan into a Roth IRA, different rules may apply. Here we are discussing a general overview of “normal” Roth IRA distributions.

Are Roth IRA distributions taxable?

When you contribute to a Roth IRA, you do so with after tax dollars, which means you have already paid taxes on your contributions. While this practice reduces the immediate tax advantage for owners of a Roth IRA, the advantage becomes obvious at the time of distribution. As long as you follow the rules set forth by the IRS, you will never have to pay additional taxes on money withdrawn from your Roth IRA.

When can distributions be taxed?

If you withdrawal earnings from your account prior to age 59 1/2 you will be taxed on those earnings. The same is true if you take money from the account before the account has been open for five years. Contributions to the Roth IRA can be distributed at any time without being subject to taxation.

Do you have to take distributions at a certain age?

Unlike the traditional IRA which requires the owner of the account to begin taking minimum mandatory distributions at age 70 1/2, the Roth IRA has no age limit for distributions. Due to this, owners of the account can use as much or as little of the assets in the account at any time without fear of losing money to the IRS for not meeting minimum mandatory contributions. Any beneficiaries of your account will be required to take distributions at the time of your death.

Are there penalties for taking distributions prior to age 59 1/2?

Withdrawal of contributions prior to age 59 1/2 will not trigger an early withdrawal penalty, however withdrawal of earnings prior to 59 1/2 will be subject to a 10% early withdrawal fee.

Are there exceptions to allow early distribution from a Roth IRA?

As with most other IRS rules, there are exceptions to the standard distribution rules. Remember, contributions can be distributed at any time, therefore the exceptions listed here apply to earnings from the account. In some cases the IRS will allow early distribution of earnings from the account without penalty. They include; death of the account owner, disability, distributions used to pay un-reimbursed medical expenses, distributions used to purchase a first home and to pay back taxes as a result of a levy placed against the IRA. It is always important to understand exactly who or what qualifies for an exception before taking an early distribution from your account.

Individual retirement accounts (IRAs) are a popular investment vehicle for individuals as well as married couples. There are several different types of IRAs available from which to choose. While there are many options when selecting an IRA, two of the more popular choices include a traditional IRA or the Roth IRA. Both retirement accounts offer unique benefits as well as what some might consider drawbacks, therefore it is important to research all of your options before making your final decision. Here we look at the Roth IRA and how you can open this type of account. We’ll also look at the best places to open a Roth IRA for no fee.

photo credit: alancleaver_2000

What is a Roth IRA?

To determine if the Roth IRA suits your individual investment and retirement goals, you must first understand how this type of account works. The Roth IRA allows your money to grow in a tax-free status due to the fact that unlike the traditional IRA which is tax deductible, contributions made to a Roth IRA are taxed at the time of contribution. This means that any money invested in your Roth IRA account will be free of taxation as long as distribution rules are met. A contributor may withdrawal contributions at anytime without paying income tax, while both contributions and earnings may be distributed without taxation once the account is at least five years old and the account holder has reached age 59 1/2.

The Roth IRA is ideal for individuals or married couples that want fewer distribution restrictions as well as anyone who anticipates being in a higher tax bracket at retirement age.

Where is the best place to open a Roth IRA?

You can open a Roth IRA in several places such as a bank, credit union, mutual fund company, brokerage firm and insurance company. Despite the fact that there are literally thousands of providers from which to choose, deciding where you open your account may be determined by your investment strategy. It is also important to determine how much it will cost to open and manage your account. Startup and annual maintenance fees as well as fees associated with changing your investments or the withdrawal of money can add up quickly, therefore many people prefer what is called a no fee Roth IRA. In all honestly the likelihood of finding any IRA account that is completely free of fees throughout the entire life of the account is close to impossible. But there are no fee Roth IRAs which basically have very minimal fees that do not have such a significant impact on your account. The key to finding low fee or no fee accounts is carefully comparing all of the providers available. In most cases to avoid the fees, brokerage companies and mutual fund companies require a minimum deposit or investment. Others may require a minimum amount to be automatically debited from your bank account each month.

Once you have decided the Roth IRA is right for you, review and compare several companies to ensure you are working with the right provider. This type of investment strategy is an excellent option for those looking to save for retirement in a tax free account.

What’s the best Roth IRA interest rate?  How do I know I am getting the Best IRA rate?  What is a IRA rate?  What do I need to know about my Roth IRA or any IRA ?  Some of these questions are hard to answer.  When it comes to the the first question “What is the best IRA interest rate?” there is no good answer.  Answers to all but the first question simply help explain why there is no good answer to that first question.

photo credit: Philippe Put

First of all, it is important to understand what an IRA isn’t.  IRA stands for Individual Retirement Arrangement.  An IRA is not an investment.  It is simply a retirement account that holds your investments.

Why Roth IRA’s Are Not Investments

The IRA serves as a retirement “account” that has your choice of investments in them.  Many people have the belief that IRA’s are like a CD and they pay an interest rate.  This may be  true but usually only if you invest in an IRA at your local bank and/or credit union.  In this case, you are purchasing a CD as the investment within the IRA account.  Because CD’s are the only investment option that is available, the rate of the CD your purchased is the sole vehicle for the rate of return.  In this case, the best IRA rate you can get on your IRA account is equal to whatever the going CD rates are at the time.  This is also true of a Roth IRA.

Consider Your IRA  an Account to hold Many Investments in

My personal financial planner told me to consider my IRA an account that holds many investments.  With his assistance, I then chose what investments should go into my IRA account based on what I felt was best for my current life status and where I expected to “end up” as retirement roles along.   Where you hope to end up and how much time you have left to get there is extremely important when choosing these investments.

Currently, I have several different types of mutual funds and ETF’s that make up the bulk of my retirement money.   The neat thing about the IRA is that I have the ability to buy stock, too.   When the market was down, I moved some of my money into some individual stocks that I felt would rebound pretty good and they did!

Important Considerations When Choosing the Investments in Your IRA

It is important to choose your investments wisely because the amount or risk you are willing to take has a direct relationship with the return you can expect.  Generally the higher the risk, the higher the return expected.  Likewise the lower the risk, the lower your expected return.  It is also important to understand where you are in your life.  If you are a Boomer like me in retirement you may want to consider less risk, because there is no time left to regain a loss or even to add much gain.  Although, I invested some of my money into individual stocks, it wasn’t enough that would have put a great strain on my retirement money.  I highly recommend getting professional help.  The initial advice is usually free.

How many investments can I have in my IRA?

To this question, he told me I can have as few investments in my IRA or as many investments as I want in my IRA.  That was a big help.  You could have all your money invested into one stock such as Whirlpool (WRL)  or Wal Mart (WMT) or spread it out across as many different stocks as you want or can afford.  But remember the old saying “don’t put all your eggs in one basket” could very well apply.  If you choose the wrong egg and it breaks, it may break you too!

So What Does My IRA Pay?

If you choose a brokerage firm to open a open a Traditional or Roth IRA, you can invest into CD’s just like at your local bank, or you can also choose from many other investments.  What your IRA pays is determined by the actual returns on all of the investments in your IRA account.  Therefore, it could pay 5% or less in the case where you invested in only CD’s, or it could be much higher, say 30% or even more, if you had invested in stocks or other more risky investments.

Sometimes Your IRA Doesn’t Pay at All

When it comes to investing in your IRA you want to be careful not to go too aggressive.  A S&P 500 index fund would have you had your IRA paying you -45% in 2008, but had you had it in individual stocks, it could have been a whole lot worse.  Think Bank of America or Lehman Brothers. Be diversified in your IRA’s and make sure to save as much as you can.

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If you have come to conclusion that you are ready to open a Roth IRA, it can be confusing on choosing the best place to setup your Roth IRA account.  In this day and age, you have many, many choices.  In fact, it’s worse that going to all you can eat buffet when it comes to plethora  of options you have. You can go to your bank, you can go to a brokerage firm, you can go online.  It’s almost to the point where you can go to Wal-Mart to open a Roth IRA account.  Not quite, but you never know.  Your situation and your needs will be the largest determinant on where the best place is to setup shop.  Here is a breakdown at the different choices you have at opening a Roth IRA and why it may be best for you.

photo credit: Andi Sidwell

Open a Roth IRA at a bank

….if the word stock market equates to a major feature horror film, then opening a Roth IRA at a bank is probably your best choice.  Why?  Typically, at a bank, if you open a Roth IRA, your only two investment options are going to be CDs or money market savings accounts.  Both of these will be covered by the FDIC limits, which for IRAs are $250,000 per account.

By setting up the Roth at your bank or credit union, you’ll never have to worry about losing principal and you’ll never have to worry about the stock market.

Be careful though. If the bank or credit union has a brokerage firm within it, and that you get referred to the financial advisor there, then you’ll be most likely won’t be investing in a CD or a savings account.

Setup a Roth IRA account at a brokerage firm

…..if you’re looking for some more investment options other than CDs or money markets, but you still need help choosing the best investment for you.  In this case, you may want to consider going to a local brokerage firm.  Going to a brokerage firm will allow you to invest into mutual funds, ETF, stock, bonds.

The one downside by going to a major brokerage firm to open a Roth IRA is that the financial advisor could be skewed in his recommendations.  If they are employed by an in insurance company, they may have their own in house proprietary annuities or mutual funds that they might try to sell you.  Also, they may have a secret alliance to a particular mutual fund company, so you may not be getting unbiased advice.  Tread carefully and make sure to read the prospectus and ask plenty of questions.

Open a Roth IRA at an independent financial planning firm

…if (Same rules apply with the brokerage firm) you want more investment choices versus a bank, an independent firm might be the best choice for you.  With an independent firm, you should eliminate any biased advice or recommendations and have investments suggested to you that is purely based on your needs.

The only downside with an independent firm is that if you are a new investor they may have certain account size minimums in bringing on new clients.  If this is the direction that you are destined to go, it never hurts to ask to see what the possibilities are of working with an independent financial advisor.

Setup Your Roth IRA directly at a mutual fund company

….if you are hardcore zealot of that mutual fund company.   For example, if you love Vanguard because of their low expense mutual funds, then it makes perfect sense to open your Roth IRA account there.  Same rule applies for Fidelity, T. Rowe  Price, American Funds, etc.  The benefit of doing so is that you should (double check with the mutual fund company) be able to switch your mutual funds holdings without every occurring a another sales charge.

The downside is that you are typically limited to the that company’s mutual funds.  Vanguard, though, has 130 domestic and 40 international funds to choose from so you still get a very decent selection.

Open a Roth IRA at a online brokerage

…if you consider yourself a “do it yourselfer” and feel educated enough to make your own investment decisions, then opening a Roth IRA account at a online brokerage firm would be the best choice for you.  By opening a Roth IRA account online, you should pay less in transaction fees, annual custodial fees, and you have the freedom and flexibility to make changes to your portfolio whenever you want.

Here’s a look at some of the best places to open a Roth IRA online if this is the way for you:

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2010 is in full swing, and by now I’m sure you’ve heard something about the Roth IRA conversion event of 2010.  All the brokerage firms are making a stir over it and maybe you’re scratching your head and wondering if its another bandwagon for you to jump on.   Before you make the leap, let’s look at the basics of the conversion and then some of the tax rules if you decide to convert.

photo credit: myuibe

What’s so special about 2010? Previously, investors who wanted to convert to a Roth IRA and had an AGI above $100,000 couldn’t do so before their income was too high.  Starting  in 2010, this restriction is lifted, allowing boomers and investors at any income level to move assets in a traditional IRA over to a Roth IRA.

To make the deal even sweeter, the IRS is allowing those who convert in 2010 to spread the federal income tax owed on the converted sum over two years, a special rule to help lessen the tax blow of having to pay it all in one year.

Splitting the Tax Bill

The tax rules on converting to a Roth IRA 2010 are a little tricky, but here’s the gist.   If you elect to defer the tax payment over the 2 years (this is default choice), whatever amount you convert in 2010 you’ll have to pay no income tax for this tax year.   The remaining will be split 50/50 over the 2011 and 2012 tax years and added as income for those years (not based on 2010 income levels). Essentially, you won’t be making the last tax payment until 2013 when you file your taxes for 2012.

Does it Make Sense to Convert to a Roth IRA?

The answer to this question will differ for every investor, depending on a number of factors including the amount of time you plan to leave the money invested, your estate planning objectives and your willingness to pay the federal income tax bill that a conversion will trigger. Here is a look at the potential benefits and drawbacks of converting.

Benefits of Converting to a Roth IRA

• Tax free gift to your heirs. Since required minimum distributions (RMDs) do not apply for Roth IRAs as they do for traditional IRAs, investors who do not need the money may leave it invested as long as they choose, which may result in a larger balance for heirs. After your death, you beneficiaries are required to take distributions, although they are not required to pay taxes on the distributions.  FYI, there are different rules apply for spouses as opposed to children and other non-spousal beneficiaries.
• Tax-free withdrawals on qualified distributions. After you’ve converted, you have five years to wait until you can withdrawal money completely tax free.  If you are already over 59 1/2, you’ll have immediate access to the conversion amount, but still have to wait five years to tap any of the earnings with no consequence.

Downsides of Converting- Tax Implications

• Pay the tax with outside monies. Investors who convert assets from a traditional IRA to a Roth IRA are required to pay taxes on the amount that is rolled over. The full amount of the conversion is usually taxable at ordinary income tax rates. If you have a nondeductible traditional IRA (i.e., your contributions did not qualify for a tax deduction because your income was not within the parameters established by the IRS), investment earnings will be taxed but the amount of your contributions will not. The conversion will not trigger the 10% penalty for early withdrawals.
• Aggregate of all Your IRA’s. If you have a mixture of pre-tax and post-tax (nondeductible IRA’s), the IRS will treat them all as “one” when you go to convert.   If, for example, you just wanted to convert just your non-deductible IRA’s so that you can minimize the taxes on the conversion, you’ll have to pay a pro-rata tax.

Pro-Rata Conversion Tax Example

For example, suppose you have $15,000 in a non-deductible IRA that hasn’t generated any earnings and own deductible IRAs worth $150,000. If you converted $15,000 to a Roth, 90% of the conversion would be taxable, because 90% of your combined IRAs were funded with deductible contributions.

Don’t Forget Required Minimum Distributions

Seniors that have already reached 70 1/2, may try to use the Roth IRA conversion as away to avoid having to take out their RMD’s for the current year.  This is not the case.  You will first have to take out the RMD amount, pay the tax, then you’ll be able to convert the rest.

If you mistakenly convert the entire amount, it could result in an excess contribution and you will be faced with the 6% excise penalty for each year that you leave it in the Roth account.  Ouch!

Is the Roth IRA Conversion Right For You?

If you are still on the fence whether converting your traditional IRA or 401k into a Roth IRA is right for you, here are some further considerations:

• A conversion may make more sense if retirement is further away. The longer your earnings can grow, the more time you have to compensate for the associated tax bill.
• Your expected tax rate will be the biggest determinant. If you expect to be in a lower tax bracket during retirement, sticking with a traditional IRA could be the best option because your RMDs during retirement will be taxed at a correspondingly lower rate than amounts converted today. On the other hand, if you anticipate being in a higher tax bracket, the ability to take tax-free distributions from a Roth IRA could be an attractive benefit.

There is no easy answer to the question: “Should I convert my traditional IRA to a Roth IRA?” Double check with your tax professional before you make the move. If you want to do some number crunching on your own, check out all these Roth IRA conversion calculators.

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It’s unanimous!  Baby boomers and investors alike love the Roth IRA account.  What’s not to love about having access to your contributions at any time or having tax free money for yourself at retirement or your heirs to inherit?  For as many as there are that love the benefits of opening a Roth IRA, there’s just as many that don’t completely understand how it really works.  What adds even more confusion is the new rules in 2010 that eliminated the AGI limits to do a Roth IRA conversion.  It’s easy to see how the rules of the Roth IRA account can get very confusing.

Here’s a quick rundown on all the Roth IRA limits: age limits, contribution limits, phaseout limits, and conversion limits.  Even though  the Roth IRA has several limits, it’s still viewed to many as the Superman of the retirement account choices.  In relation to it’s potential benefit for the long haul,  the Roth IRA has very few limitations.

The Many Limits of the Roth IRA

Aged to Perfection

The first limit we should talk about is the age limit- young and old.   There is no age limit for opening a Roth IRA.   Essentially, a minor can start a Roth IRA so as long as they have “earned income”.  Operating a lemonade stand won’t cut; either will washing your neighbor’s car.  The income has to be reportable to the IRS.  Same rules applies to boomers and beyond.  So as long as there is earned income, you can continue to add money.

Another perk for boomers and the Roth is the Required Minimum Distribution (RMD) limit- there isn’t one.  Where with a traditional IRA you are required to take out RMD’s at 70 1/2, with a Roth you don’t.  Very nice estate planning tool for passing on even more tax free money to your heirs.

Roth IRA Account Contribution Limits

When Roth IRA’s first became available in 1998, you could only contribute $2,000 and that held true until 2002.  Since then the contribution limits has gradually increased until its high of $5,000 in 2008. Contribution limits have stayed at $5,000 for 2010.  For boomers over the age of 50, you are entitled to catch up.  Catch up contribution remain at $1,000 for 2010 for a total contribution limit of $6,000.  If you’re married, that’s $6,000 for you and your spouse.

Contribution Year	49 and Under	50 and Over (Catch Up)
2009	$5,000	$6,000
2010	$5,000	$6,000

Roth IRA Phaseout Limits

The Roth IRA eligibility is not based on your gross income. This is where people can get a bit confused. The ability to contribute to a Roth IRA is based upon your Modified Adjusted Gross Income (MAGI) .  For those that don’t know the difference from the two, let’s break it down really quick.

Modified Adjusted Gross Income  is the amount you earn after calculations have been made in order to figure out how much your federal income tax obligation is . After you’ve file your taxes (or in the process of), just look at your form 1040 to see what your MAGI is.  This is the figure you should use when deciding whether you are eligible to open a Roth IRA account or not.  If you’re not totally clear, then consult with your tax accountant or financial advisor to help you sort it out.

2010 didn’t see the the phaseout limits increase that much.   Single filers received no improvement, while joint filers increased $1,000 to the bottom and top ranges.

For those that fall in the middle of the phaseout range, it can be tricky trying to find out how much you can exactly contribute to a Roth.  Below is three examples of how much you’ll be able to contribute based on your MAGI.  For the purposes of the illustrations, we’ll be assuming that is an individual filing single.

Modified AGI Roth IRA Phaseout Limits

Roth IRA Phaseout Examples

Example 1: MAGI is $95,000. This is pretty basic.  Contribution allowed is $5000.  So far, so good.

Example 2: MAGI is $135,000. Bummer!  Sorry Charlie, you make too much money to contribute to a Roth IRA. You still have the backdoor Roth IRA option, though.

Example 3: MAGI is $115,000. This is where it gets a wee bit complicated.  You might want to break out your calculators on this one or just follow these easy steps.

• Step 1. Find the amount of the phase for you. In our example, the phase is $15,000. ($120,000-$105,000).
• Step 2. Subtract your AGI from the upper amount of the phase. We would use $120,000-$115,000 = $5000.
• Step 3. Divide the amount in Step 2 ($5000) by the phase range ($15000) to arrive at .3333 or 33.33%
• Step 4. Take 33.33% of the contribution limit of $5000 for a total contribution limit of $1666.67. So $1666.67 is the full amount that a single/head of household under the age of 50 could contribute to their Roth IRA with an MAGI of $115,000. If you need to take a water break after that one, I totally understand.

Roth IRA Conversion Limits

Whether you are filing as an individual or married filing joint, the adjusted gross income level of $100,000 will become nonexistent for the Roth IRA  conversions of 2010.  For higher wage earners, this is a prime opportunity to convert money into the Roth IRA to allow your money to have tax-free growth at retirement.

photo credit: scottwills

Don’t Forget the Nondeductible IRA Account

In the past, there was nothing all that attractive about the nondeductible IRA. You did get tax deferral, but no immediate tax deduction and you still had to pay tax at retirement. The Roth IRA conversion event of 2010 now allows you to use a nondeductible IRA  as a backdoor way into the  Roth. If you are not eligible to contribute new money into a Roth IRA in 2010, you can open up a traditional non-deductible IRA and immediately convert it to a Roth.  This is especially attractive for boomers that have been putting off opening a Roth IRA.

All Limited Out

As you can see, there are many limits when it comes to Roth IRA.   If you haven’t taken a close look,  it’s time you do.  It’s never too late to start a Roth IRA Account.

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If you are a baby boomer and you have either lost your job, left your job for a new one or retiring, then you have an important choice to make regarding your 401k plan.  If retirement is here (Congratulations!) then the most common approach is rolling over the 401k into a traditional IRA.  This process is very easy and allows you to continue the tax deferral process.  With the  AGI limits on Roth IRA conversion now being non existent in 2010, you now have the choice to do a direct rollover of your 401k into a Roth IRA.  There, of course, is a tax consequence for doing so.  Does rolling over your 401k into a Roth IRA make sense for you?  Let’s find out.

photo credit: jayallen

How the Rules to Rollover 401k into a Roth IRA have changed.

Before 2010, it was much more difficult to rollover your 401k into a Roth IRA.  You have to follow the below steps, but could only do so if you didn’t exceed the phaseout limits.

1. Open a traditional IRA account with a brokerage firm
2. Rollover your 401(k) from your employer to your traditional IRA account
3. Open a Roth IRA account
4. Convert the  traditional IRA account to the Roth IRA account.

As you can see, the process is a bit of the pain in the butt. Now the process is much more streamlined and much easier.

The Roth IRA to 401k Rollover Process

Now the process can be completed in two easy steps:

• #1: Open a Roth IRA Account.
• #2: Contact your human resources department who may send you to the 401k plan administrator. Request the rollover paperwork and complete it.  Somewhere on the form, you should now have the option to roll it directly into a Roth IRA.

Recap on Roth IRA Conversion Rule 2010

For 2009, you and/or your spouse are limited to $100,000 AGI to do the the Roth IRA conversion.  That also applies to converting from a 401k, as well.  In 2010, anybody will be able to take all their traditional IRA’s and old retirement plans and convert them to a Roth IRA.  The amount you convert will be taxed, but you can spread the bill over three years. (The tax would be deferred in 2010. Then 50% would be paid in 2011 and the rest in 2012.)

What If the Rollover Check is sent directly to me?

photo credit: wintersoul1

If you receive a distribution check from your 401k rollover to a Roth IRA then chances are they will hold around 20% for taxes. If you want a direct 401k rollover to a Roth IRA, you may want to send that check back to your employer 401k provider and ask to be sent all of your eligible retirement distribution directly to your new Rollover IRA account (not as a check, or they will just give you 80% again). You have 60 days upon receiving the check to get the money into the Roth IRA- no exceptions!  So don’t procrastinate on this one.

What About the Roth 401k?

If you already had a Roth 401k at work, then the process is that much simpler. You don’t have to worry about implementing a conversion.   You would just roll the Roth 401k directly into the Roth IRA.

Does it Make Sense to Roll Into the Roth IRA?

Rolling your 401k into a traditional IRA makes sense most of the time for many reasons.   But rolling all your 401k into a Roth IRA takes some careful planning and reasoning.  Here are a few reasons that you might want to consider:

• If you are officially retired and do not expect to have a considerable income in the year that you convert
• You expect the taxes to keep increasing through your golden years
• You have beneficiaries that you want to benefit from the Roth IRA

You Can Rollover Your 401k by Following These Steps

1. You have to have a Roth IRA open/established before you can do any of this.
2. Don’t forget about the AGI limits if you are doing this in 2009.
3. Rolling from a traditional 401k to a Roth IRA will be a taxable event.

Investors love the Roth IRA for the potential tax-free income at retirement.  Who doesn’t like skimming the government from paying more tax? The rules of the Roth IRA make it a great saving tool because you have more flexibility when you can withdraw the funds.  Retiring early or an unexpected emergency make the Roth IRA the king of retirement tools to use because you have access to the money. If you ever do consider taking money out of your Roth IRA, you better know all the withdraw rules to avoid paying an unnecessary penalty.

photo credit: Nicobobinus

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Roth IRA Contributions are Cool, but Lay off Your Earnings.

I amazed the number of people that don’t know that you can withdraw your Roth IRA Contributions at any time without tax or penalty.  In layman terms: You can get what you put in.  With your earnings, that’s another story.  There is a certain order that has to come out to make sure you follow the Roth IRA rules correctly.

Roth IRA Ordering Rules for Distributions:

1. First wave that comes out our contributions.  I stated that above and will state it again:  Roth IRA contributions come out first.  There is no tax or penalty that is applied. What about the five year rule?  Nope.  Not applicable.  You can take your money with no worries.
2. The next wave according to the IRS rules are the conversions and rollover contributions to your Roth. To understand what comes out first we have to break out a familiar accounting term: FIFO.  This stands for first, in first out.  This means that a conversion that occurred in 2004 would come out first before a conversion made in 2007.  Pretty simple, right?  Keep in mind that the taxable portion will come out first in the event there is any non-taxable amount included.  The IRS practices FIFO, too; but more in how they get paid.
3. The last part is the earnings. Finally, earnings accrued by a Roth IRA are distributed. So in other words, rarely withdraw your regular contribution and whatnot for your tax, but if your Roth has realized earnings from contributions, the earnings will be subject to income tax, they are withdrawn.

What Makes Your Roth IRA Withdrawal a Qualified Distribution?

This is where the Roth IRA rules can get tricky.  If you have owned the Roth less than five years even if you are 59 1/2, the earnings will still be hit with taxes and the 10% penalty.  Greater than five years, then you are in the clear.  You then are allowed to take a “qualified distribution” from your Roth and throw your nose up to the IRS because you don’t have to give them a dime of it.  Enjoy that moment when it comes! The same five year rule applies to Roth IRA conversions, too.  The added nuance with conversions is that each conversion starts a brand new five year clock.  Remember: after 59 1/2 this is just the earnings.  Contributions are yours whenever you want them.

Roth IRA Five Year Rule For a Qualified Withdrawal

photo credit: Môsieur J. [version 3.0b] In assessing the five year holding rule, the time starts on January 1st of the tax year of you make your first contribution.  Even if you waited until the deadline of April 15th of the following year to make the contribution, its retroactive the January 1.

Converting More Than One Roth IRA

Remember if you are planning on converting more than one IRA in 2010, the IRS will aggregate them all together. This includes all traditional IRA’s and non-deductible IRA’s.  The only thing excluded are 401k’s, 403b’s and 457′s.  If you do convert these in the same tax year after you converted, they will be added to the total.

Jacob has a traditional IRA of $12,000, which he has only contributed $6,000 to. His income now exceeds the Roth IRA phaseoutlimits and wants to use a non-deductble IRA and immediately convert it. When he contributes $5,000 to the IRA and immediately converts, he will have to include $11,390 to her income (67% of $17,000) instead of just the $5,000 of the IRA that maybe he was hoping.

Jeff Rose, a Certified Financial Planner in Illinois who authors the blog Good Financial Cents has an excellent post on the Roth IRA conversion tax rules.  I encourage you to check it out.

Seek Advice

If, for any reason, you have to take a distribution or trying to calculate the tax on a conversion, seek the counsel of a tax professional.  It can get tricky and it’s important to have someone who knows the rules. Need to Open an IRA? You can or Zecco account. Zecco is currently offering $0 stock trades. Don’t delay – fully fund your IRA today!