Anybody with taxable compensation for the year may establish and fund a Roth IRA. But whether or not you can contribute and the amount of your contribution limit depends on your marital status and whether your compensation falls within modified adjusted gross income (MAGI) requirements: if you make more than $99,000 individually or $156,000 as a married couple, you cannot contribute the full amount (and may not be able to contribute at all).
Contribution Limits & Guidelines
Most of you will be able to set up a Roth IRA any time of the year but your contribution is limited. You may commit up to the limits detailed above, up to 100% of your compensation. Earned income includes wages, salaries, bonuses, tips, professional fees, commissions, self-employment income, or alimony. In any year you did not work, contributions can’t be made unless alimony is received or a joint return is filed with a spouse who has an income. If your age reached 50 by December 31st, you can contribute a catch-up contribution. Contributions can be made beyond 70 1/2 and the account can be maintained for your entire life. Contributions can be made during any time during the year, or by the tax return due date. Contribution limits are dependent on if contributions are made to Roth IRAs or to both Traditional and Roth IRAs. In 2008 and 2009, the maximum you can contribute is $5,000 a year (unless you’re over 50 the maximum is $6,000).
Contribution Limits Deadline
Contributions must be postmarked on or before April 15. If April 15 falls on a weekend, the deadline is the following business day.
Contribute After Filing Your Tax Return
Your contribution can be made anytime between January 1 and April 15 of the following year even if you already filed tax return prior to April 15. Be certain to tell your trustee/custodian the year the contribution attributed too.
Simple and 401K to Roth IRA Conversions
A Roth IRA conversion is a taxable transaction from a Traditional, SEP or SIMPLE IRA to a Roth IRA. Simple IRA assets can’t be converted into a Roth IRA until after the employer first contributed to the employee’s Simple IRA. Conversion methods from a Traditional IRA can be made in the form of a rollover, firm-to-firm transfer or with your existing custodian. If the conversion method fails for any reason related to the limits there are tax consequences. A failed conversion is a distribution from the Traditional IRA, and an improper contribution to a Roth IRA. The distribution could be subject to full income tax in the year of the failed conversion, and could also be subject to a 10% early distribution penalty (unless Section 72(t) applies). Additionally, a 6% annual excise tax on excess contributions to a Roth IRA could also apply. This tax is imposed annually until the excess contribution is withdrawn.
You can recharacterize your Roth IRA conversion by directly redirecting the assets to back to a Traditional IRA. You must do this before the due date, including extensions, for filing your tax return with conversion Form 8606.
Traditional and Roth IRA Distributions
Traditional IRA’s require you to begin distributions at age 70 1/2. This rule doesn’t apply to Roth IRAs. You’re never required to take distributions from your Roth IRA. However, if your estate includes Roth IRA assets after your death, your beneficiaries will have required minimum distributions.
The rules for them also permit you to do something that isn’t allowed for Traditional IRAs: withdraw the nontaxable part of your money first. Distributions from the latter come partly from earnings and partly from contributions. Taking money out of a Roth IRA, the first dollars withdrawn are considered to be a return of your non-rollover contributions. You can take funds out any time, for any reason, without paying tax or penalties.
Qualified vs. Non-Qualified Distributions
Qualified distributions from a Roth IRA are not subject to the 10% IRS imposed early withdrawal penalty or includible in income. A qualified distribution is a distribution after the owner has reached 59 1/2 (or who is disabled, a first-time home buyer, or in the case of a beneficiary of the estate, death) and the account has been funded for a five-year period, beginning on the first day of the tax year in which a conversion from a regular IRA is made or for which a contribution is made, and ending with the last day of the fifth year from the beginning year.
If a distribution does not meet the conditions as defined above, then the distribution is non-qualified.
Non-Qualified Distributions
An early non-qualified distribution from a Roth IRA may be subject to a 10% tax penalty, provided that no exceptions apply. Generally, returns of regular contributions and returns of conversion contributions that were in the account for five years aren’t subject to the 10% penalty. However, returns of conversion contributions that do not meet these criteria are subject to the 10% early distribution tax. Exceptions include: Disability, Qualifying medical expenses, Qualifying education expenses, Unemployment, Qualifying first home purchases, Death, or Levy.