Category Archives: Retirement Accounts

Reacquainting yourself with the Roth IRA

This article was originally published in Hershey Advisors’ monthly Tax and Business Alert.

If you’ve looked into retirement planning, you’ve probably heard about the Roth IRA. Maybe in the past you decided against one of these arrangements, or perhaps you just decided to sleep on it. Whatever the case may be, now’s a good time to reacquaint yourself with the Roth IRA and its potential benefits, because you have until April 18, 2016, to make a 2015 Roth IRA contribution.

Free withdrawals2

With a Roth IRA, you give up the deductibility of contributions for the freedom to make tax-free qualified withdrawals. This differs from a traditional IRA, where contributions may be deductible and earnings grow on a tax-deferred basis, but withdrawals (less any prorated nondeductible contributions) are subject to ordinary income taxes — plus a 10% penalty if you’re under age 59½ at the time of the distribution.

With a Roth IRA, you can withdraw your contributions tax-free and penalty-free anytime. Withdrawals of account earnings (considered made only after all your contributions are withdrawn) are tax-free if you make them after you’ve had the Roth IRA for five years and you’re age 59½ or older. Earnings withdrawn before this time are subject to ordinary income taxes, as well as a 10% penalty (with certain exceptions) if withdrawn before you are age 59½.

On the plus side, you can leave funds in your Roth IRA as long as you want. This differs from the required minimum distributions starting after age 70½ for traditional IRAs.

Limited contributions

For 2016, the annual Roth IRA contribution limit is $5,500 ($6,500 for taxpayers age 50 or older), reduced by any contributions made to traditional IRAs. Your modified adjusted gross income (MAGI) may also affect your ability to contribute, however.

In 2016, the contribution limit phases out for married couples filing jointly with MAGIs between $184,000 and $194,000. The 2016 phaseout range for single and head-of-household filers is $117,000 to $132,000.

Conversion question

Regardless of MAGI, anyone may convert a traditional IRA into a Roth to turn future tax-deferred potential growth into tax-free potential growth. From an income tax perspective, whether a conversion makes sense depends on whether you’re better off paying tax now or later.

When you do a Roth conversion, you have to pay taxes on the amount you convert. So if you expect your tax rate to be higher in retirement than it is now, converting to a Roth may be advantageous — provided you can afford to pay the tax using funds from outside an IRA. If you expect your tax rate to be lower in retirement, however, it may make more sense to leave your savings in a traditional IRA or employer-sponsored plan.

Retirement radar

Roth IRAs have become a fundamental part of retirement planning. Even if you’re not ready for one just yet, be sure to keep the idea of opening one on your radar.

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Top Year-End IRA Reminders from IRS

The following is IRS Special Edition Tax Tip 2015-21:

Individual Retirement Accounts, or IRAs, are important vehicles for you to save for retirement. If you have an IRA or plan to start one soon, there are a few key year-end rules that you should know. Here are the top year-end IRA reminders from the IRS:

  • Know the contribution and deduction limits.  You can contribute up to a maximum of $5,500 ($6,500 if you are age 50 or older) to a traditional or Roth IRA. If you file a joint return, you and your spouse can each contribute to an IRA even if only one of you has taxable compensation. You have until April 18, 2016, to make an IRA contribution for 2015. In some cases, you may need to reduce your deduction for your traditional IRA contributions. This rule applies if you or your spouse has a retirement plan at work and your income is above a certain level.
  • Avoid excess contributions.  If you contribute more than the IRA limits for 2015, you are subject to a six percent tax on the excess amount. The tax applies each year that the excess amounts remain in your account. You can avoid the tax if you withdraw the excess amounts from your account by the due date of your 2015 tax return (including extensions).
  • Take required distributions.  If you’re at least age 70½, you must take a required minimum distribution, or RMD, from your traditional IRA. You are not required to take a RMD from your Roth IRA. You normally must take your RMD by Dec. 31, 2015. That deadline is April 1, 2016, if you turned 70½ in 2015. If you have more than one traditional IRA, you figure the RMD separately for each IRA. However, you can withdraw the total amount from one or more of them. If you don’t take your RMD on time you face a 50 percent excise tax on the RMD amount you failed to take out.
  • IRA distributions may affect your premium tax credit. If you take a distribution from your IRA at the end of the year and expect to claim the PTC, you should exercise caution regarding the amount of the distribution.  Taxable distributions increase your household income, which can make you ineligible for the PTC.  You will become ineligible if the increase causes your household income for the year to be above 400 percent of the Federal poverty line for your family size. In this circumstance, you must repay the entire amount of any advance payments of the premium tax credit that were made to your health insurance provider on your behalf.

Each and every taxpayer has a set of fundamental rights they should be aware of when dealing with the IRS. These are your Taxpayer Bill of Rights. Explore your rights and our obligations to protect them on IRS.gov.