Retirement. A Guide to Roth IRAs

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1 Retirement A Guide to Roth IRAs A Roth IRA is an individual retirement account named for the late Senate Finance Committee Chairman, William Roth, Jr. who championed the creation of this new type of IRA. Although designed for retirement savings, the Roth IRA offers different tax incentives than a traditional IRA. Like a traditional IRA, earnings on Roth IRA contributions accumulate tax-deferred. Unlike a traditional IRA, contributions to a Roth IRA are never tax-deductible. The money you contribute to a Roth IRA can be withdrawn tax-free at any time and if you qualify, you can also withdraw any earnings income tax-free as well. WHO CAN CONTRIBUTE TO A ROTH IRA? Anyone can contribute to a Roth IRA if they have earned income and their Modified Adjusted Gross Income (MAGI) 1 does not exceed certain limits set by the IRS. Earned income is generally your wages or salary that you earn from working. It also includes combat pay, taxable alimony and separate maintenance payments. It does NOT include passive forms of income, even if they are taxable, like earnings or profits from property such as rental income, interest or dividend income from your savings or investments, pension or annuity income. CONTRIBUTION LIMITS AND DEADLINES You have until the due date for filing your federal income tax return to make Roth IRA contributions each year. Generally, this is April 15th. If April 15th falls on a weekend or a holiday, the due date is extended to the next business day. Tax extensions do not extend the contribution deadline. 1 Modified Adjusted Gross Income (MAGI) is determined by subtracting from your adjusted gross income any conversion from a traditional IRA to a Roth IRA and adding back certain deductions and exclusions you may have taken on your income tax return. Consult your tax professional for assistance in determining your MAGI. BFEC EXP 02/28/2017 A GUIDE TO ROTH IRAs 1

2 The annual contribution limit is the lesser of: $5,500 for 2014 and 2015 ($6,500 if you are age 50 or older) or 100% of your earned income This annual contribution limit is a combined limit between any Roth or traditional IRAs in your name. For example, if you have both a traditional and Roth IRA, you cannot contribute $5,500 to each for 2015, but have $5,500 in total to contribute between the two. There is no limit to the number of Roth IRAs or traditional IRAs you can own, however, you will be limited to contributing no more than the annual contribution limit each year regardless of how many IRAs you have. You are eligible to contribute to a Roth IRA if: You (or your spouse if filing a joint tax return) earn income or compensation from employment, and Your earned compensation (or the combined compensation of you and your spouse if filing a joint return) is less than or within applicable IRS limits. See below for the current income eligibility limits. ROTH IRA INCOME LIMITS Tax Filing Status Year Full Contribution If MAGI* is at or below: Partial Contribution If MAGI is between: No Contribution If MAGI is at or above: Single or Head of Household $116,000 $114,000 $116,000 - $131,000 $114,000 - $129,000 $131,000 $129,000 Married, Filing Jointly $183,000 $181,000 $183,000 - $193,000 $181,000 - $191,000 $193,000 $191,000 Married, Filing Separately** $0 $0 $0 - $10,000 $0 - $10,000 $10,000 $10,000 *If married filing separately, and did not live with your spouse at any time during the year, see MAGI for Single or Head of Household PARTICIPATION IN YOUR EMPLOYER S RETIREMENT PLAN DOESN T MATTER Your participation in an employer s retirement plan does NOT affect your ability to contribute to a Roth IRA. That means you can fully fund your 401(k) at work and make Roth IRA contributions for the same tax year assuming your MAGI falls within the eligible limits above. SPOUSAL CONTRIBUTIONS For married individuals where only one spouse works, a Roth IRA contribution can be made for the non-working spouse, as long as a joint return is filed, MAGI does not exceed the annual income limit, and the amount contributed for both spouses does not exceed the lesser of compensation earned or the annual contribution amount. For example, if husband and wife combined only have $8,000 in earned income, then between the two Roth IRAs they cannot exceed $8,000 in contributions. They can split the amount any way they choose, as long as they do not exceed the $5,500 limit for 2014 or 2015 ($6,500 if they are age 50 or older) per Roth IRA. BFEC EXP 12/31/2014 A GUIDE TO ROTH IRAs 4

3 NO AGE LIMITS There is no minimum or maximum age requirement for opening a Roth IRA. Anyone of any age can have a Roth IRA, assuming the income requirements are met. This means if you are still earning income after the age of 70, you can still contribute to a Roth IRA as long as your income falls within the above limits. It also means that minor children can have Roth IRAs, if they are earning income. For example, if your teenager works part-time or just over the summer, 100% of their earned income (up to $5,500 for 2014 and 2015), could be contributed to a Roth IRA. Although the minor child must have earned the income for the Roth IRA contribution, there is no requirement that the person earning the income must make the contribution. Parents or grandparents may make Roth IRA contributions on behalf of children or grandchildren. The adult will have to establish and make all investment decisions for the minor until they reach the age of majority for their state of residence. ROLLOVERS Tax-free rollovers or transfers between your Roth IRAs are available. Rollovers must be completed within 60 calendar days, otherwise taxes and IRS penalties may apply. You are allowed only one IRA-to-IRA rollover in a 12- month period, but unlimited number of direct trustee-to-trustee transfers. If your employer offers a retirement plan with Designated Roth Contributions, sometimes referred to as a Roth 401(k) or Roth 403(b), those balances may also be rolled into your Roth IRA tax-free when you retire or separate from service. However, you cannot roll over Roth IRA balances into an employer-sponsored retirement plan. CONVERSION CONTRIBUTIONS (AND RECHARACTERIZATIONS) Roth IRAs can also receive another type of rollover, called a conversion contribution. A conversion allows you to move balances you currently maintain in a traditional IRA or your employer s retirement plan into a Roth IRA. Conversion contributions are not limited by your age or your income. However, you must pay income taxes on any deductible or pre-tax balances converted to the Roth IRA for the calendar year in which the conversion takes place. If the conversion is completed properly, there is no 10% IRS early withdrawal penalty on the taxable amount of the conversion, even if you are younger than age 59 ½. Conversions can be accomplished directly between financial institutions or you can receive a distribution and roll it/convert it to a Roth IRA within 60 calendar days. Conversions are not limited to one rollover per year. You may also convert as much or as little as you like. Because conversions create taxable income which could force you into a higher income tax bracket, make sure you review your situation with your tax professional before you do a conversion. You may want to consider converting to a Roth IRA over several years to spread out the tax liability over multiple years. If your IRA contains after-tax amounts, any conversion to a Roth IRA will contain a pro-rata allocation of both pre-tax and after-tax amounts, even if the pre-tax and after-tax dollars are segregated in separate accounts. For example, if you have a rollover IRA and another IRA that has been funded solely with non-deductible BFEC EXP 12/31/2014 A GUIDE TO ROTH IRAs 5

4 contributions, you cannot elect to convert your after-tax IRA contributions to the Roth IRA tax-free and leave the taxable amounts in the IRAs. Your two IRAs would be one IRA for determining the taxable amount of the conversion and each dollar converted - regardless of which account is making the distribution - would represent a pro-rata share of rollover contributions, non-deductible contributions, and earnings on those contributions. Only the portion that represents the distribution of after-tax dollars would tax free. However, if you do not have any existing IRAs (traditional, rollover, SEP or SIMPLE IRAs), you establish a traditional IRA, fund it with non-deductible contributions, and then immediately convert it to a Roth IRA, your income tax liability would be limited to any earnings that accumulated in the traditional IRA between the time of contribution and the time of conversion. This approach, if repeated annually, is sometimes referred to as funding a Roth IRA through the back door. You also have the ability to undo a conversion. If you change your mind and decide you do want to incur the tax liability for the conversion, you have until October 15th of the year following the conversion to move it back. This is called a recharacterization and if done properly will result in no tax liability or IRS penalties. If you later decide to redo the conversion, you must wait at least 30 days or until January 1st of the following year, whichever is longer, before converting again. If you are over age 70 ½, it is also important to note that you cannot convert your required minimum distributions to a Roth IRA. But by converting to a Roth IRA before reaching age 70 ½, you can eliminate the need to take required distributions from your IRAs or employer retirement plans. ROTH IRA DISTRIBUTIONS You always have access to the money in your Roth IRA. However, under certain circumstances the distributions may not be income tax-free and could be subject to IRS penalties. Roth IRA distributions can come from one of three sources and must follow ordering rules. Each source must be exhausted before the next source is distributed. As the table below shows, how the distribution is taxed and if IRS penalties apply is dependent upon the source and when the withdrawal is made. It is important to keep proper records of your Roth IRA transactions so you or your tax professional can file the appropriate tax forms as needed. BFEC EXP 12/31/2014 A GUIDE TO ROTH IRAs 6

5 Source Ordering Rule Taxes 2 and Penalties 1. Annual Contributions Are distributed first and can be taken at any Income tax-free time, for any reason. 2. Conversion Contributions and Rollover Amounts 3. Earnings If applicable, and only after all annual contributions have been distributed from all Roth IRAs you own. All taxable conversions and rollover amounts are distributed before any nontaxable amounts. Only after all annual contributions and conversion contributions have been withdrawn from all Roth IRAs you own. Taxable amounts may be subject to a 10% early withdrawal penalty if taken within five years of the conversion contribution if you are younger than age 59 ½, unless certain exceptions apply. 3 Qualified Distributions are income tax-free. A distribution is qualified only if: - You have had the Roth IRA for five years AND it is for one of the following reasons: You are age 59 ½ or older You are disabled You are a first-time home buyer ($10,000 limit) You are a beneficiary taking distributions after death of the owner If not a qualified distribution, earnings are subject to income tax and possibly the IRS 10% early withdrawal penalty, unless certain exceptions apply. 3 NO REQUIRED MINIMUM DISTRIBUTIONS (RMDS) Unlike traditional IRAs, there is no requirement to begin taking RMDs at any age. During your lifetime, withdrawals from Roth IRAs are a matter of choice. However, if you have named non-spouse beneficiaries - such as children or grandchildren - they must receive RMDs after your death. Generally, beneficiary RMDs begin in the year following your death, continue over the beneficiary s lifetime, and are income tax-free. 2 State taxes may also apply, even in situations where Roth IRA distributions are exempt from federal income taxes. Contact your tax professional or state department of revenue for information regarding taxation of Roth IRA distributions. 3 The IRS 10% early withdrawal penalty may be waived if the distribution is due to a first-time home purchase ($10,000 limit), disability, death, unreimbursed medical expenses that exceed 10% of AGI, a series of substantially equal periodic payments, qualified higher education expenses, medical insurance premiums when unemployed for 12 weeks or longer, IRS levy, qualified reservist distribution, or the amount is rolled over within 60 calendar days. BFEC EXP 12/31/2014 A GUIDE TO ROTH IRAs 7

6 WHAT HAPPENS TO A ROTH IRA AFTER DEATH? Like with traditional IRAs, the fair market value of your Roth IRA is included in your estate for estate tax purposes after your death. If your beneficiary is your surviving spouse, he or she can roll over the Roth IRA and make it his or her own. If your beneficiary is not your spouse, he or she will be required to take distributions from the Roth IRA, generally over his or her lifetime, beginning in the year following your death. Although required to take distributions, those distributions are generally income tax-free to your beneficiary. If any earnings are distributed to your beneficiary before the end of the 5-year period that begins with your first Roth IRA contribution, the earnings would be taxable to your beneficiary, but no 10% early withdrawal penalty will apply regardless of the age of the beneficiary. DECIDING BETWEEN A TRADITIONAL AND ROTH IRA Both traditional and Roth IRAs offer great opportunities to save for retirement. Choose the IRA that is right for you and fund it annually. How do you decide which type of IRA is right for you? Start with identifying which IRA options you are eligible for. Are you eligible to receive a tax deduction for a traditional IRA? Are you eligible to contribute to a Roth IRA? If you are lucky enough to have both options available to you, consider the following questions: How will you handle the tax deduction of a traditional IRA? Will you invest or spend the additional savings the tax deduction provided? If you do not have a disciplined approach to saving, the tax deduction a traditional IRA offers may be of little help in building your retirement assets. How soon will you need access to your retirement savings? If you anticipate needing your IRA for income before age 59 ½, the tax and penalty free access to contributions that the Roth IRA provides may be more desirable. Will your tax bracket during retirement be higher or lower than your current bracket? This is an important question when looking ahead to the taxation of traditional IRA withdrawals versus tax-free withdrawals from a Roth IRA. Ask your Benjamin F. Edwards financial consultant for a free customized analysis to help you sort through your IRA alternatives. IMPORTANT DISCLOSURES The information provided is based on internal and external sources that are considered reliable; however, the accuracy of this information is not guaranteed. This piece is intended to provide accurate information regarding the subject matter discussed. It is made available with the understanding that Benjamin F. Edwards & Co. is not engaged in rendering legal, accounting or tax preparation services. Specific questions on taxes or legal matters as they relate to your individual situation should be directed to your tax or legal professional. BFEC EXP 12/31/2014 A GUIDE TO ROTH IRAs 8

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