2010 will mark as one of the most exciting years of the Roth IRA account since its creation in 1997. Many of the basic rules and contribution limits have sustained, but what is creating most of the hype is the 2010 Roth IRA conversion event. One thing that hasn’t changed is the tax free money waiting for you at retirement by contributing to a Roth IRA. Once again: TAX FREE MONEY. I repeated that for the benefit of those that haven’t opened a Roth IRA account yet. Without further ado, let’s look at some of key rules of the Roth IRA for 2010.
1. Contribution Limits For 2010-2011
Contribution limits have stayed at $5,000 for 2010 and 2011. Are you 50 and over? Catch up contribution remain at $1,000 for a total of $6,000. It’s still up in the air whether Roth IRA limits will increase next year, so stay tuned.
|Contribution Year||49 and Under||50 and Over (Catch Up)|
2. 2010 is the Year of the Mighty Conversion
If you haven’t heard of the 2010 Roth IRA Conversion event, then you obviously haven’t visited my blog before. That’s okay, I forgive you. While 2010 is the actual year that you will be able to convert, the income to be claimed can be deferred until 2011 and 2012. Expecting a vast majority to take advantage of this, the IRS has set up special provision on how the tax will be paid. The IRS has granted you the option to claim 50% of the conversion amount as income in 2011 and the remaining 50% in 2012. Keep in mind that this is only in 2010. After 2010 the taxes will all be paid in full the following year going forward.
3. The “Take Back” Rules
If you plan on converting your Traditional IRA’s and 401k’s into Roth IRA’s, I suggest you do it sooner than later for a few reasons: 1. The market is still in a recovery phase and you could benefit from converting when your account balances are lower and pay less income tax. 2. If that strategy backfires, you can always do a Roth IRA Recharacterization, better know as the conversion “take back”. A recharacterization allows you to reverse the conversion completely. This could be the case if the market were to tank again or if you had an unexpected increase in income which would make your tax liability more than care to share with the IRS. You have until October 15th of the calendar year after the year you converted to recharacterize. For 2010, that would be October 15, 2011.
4. Phaseout Limits Did Increase….Barely
Wage earners that are on the outside looking in when it comes to a Roth IRA didn’t get much help in the phaseout limits. Single filers received no improvement, while joint filers increased a whopping $1,000 to the bottom and top ranges. Don’t worry though, you may still be in luck (See #5).
Roth IRA Phase Outs For 2011
Once again phaseout limits did increase for 2011, but barely. The limits have increased between $1,000 and $2,000 this year.
For Roth IRAs single taxpayers with an annual Modified Adjusted Gross Income (MAGI) over $107,000 begin to see their contribution limit decrease until at $122,000 it goes away entirely. The contribution limits for Married Filing Jointly investors are $169,000-$179,000. (You can see last year’s limits above).
5. Roth IRA- Phased Out But Not Out
Many people have wanted to take advantage of the Roth IRA for the past several years, but couldn’t because they surpassed the Roth IRA phaseout limits. Many then settled for the pretax substitute of the traditional IRA. The only problem with the traditional IRA (other than paying taxes at retirement) is that after certain income limits you no longer get a tax deduction for contributing to one. You still get the tax deferred growth, but that’s it.
If you are an active participant (making annual additions or accruing a benefit) in a company plan and make more than $65,000 as a single taxpayer in 2009 (or $109,000 as a married joint taxpayer) then you are disqualified from taking the full deduction. What you are then left with is the nondeductible IRA.
Introducing the Nondeductible IRA
In the past, there was nothing all that attractive about the nondeductible IRA. With 2010 just around the corner, the nondeductible IRA has become a very popular tool to allow high wage earners a way into the Roth IRA- a “backdoor” way. A high wage earner can contribute to a nondeductible IRA with the sole intentions of converting it in 2010.
By contributing to the nondeductible IRA, you will only be responsible to pay what gains you’ll have from now until you convert in 2010. If 2009 will be the first year to contribute, then unless you happen to pick a one in a million shot, your tax liability should be minimized.
6. College Savings As a Backup
Traditionally a Roth IRA is used for saving for retirement…..duh, right? Many don’t know that there is a provision that allows you to withdraw from your Roth IRA to pay for “qualified higher education” expenses while avoiding the 10% early withdraw penalty. (This pertains to the earnings, you can withdraw your contributions at any time). Who is this appropriate for? 529 college savings plans are a superior way to save, but if you’re behind in saving for retirement then this strategy might suit you. It’s better to have extra savings tied up in the Roth versus a college savings plan that might never get used.
7. Direct Rollovers From 401k’s to Roth IRA’s Just Got Easier
Prior to 2010, it was a pain trying to convert a 401k into a Roth IRA. First, you had to set up a traditional IRA and then roll the 401k into a traditional IRA. Then you would have to open a Roth IRA account and then complete the conversion paperwork. Once the conversion was complete, you would then close the Traditional IRA since it was no longer needed. (All that paperwork for nothing.) But that was then and this is now. In 2010, you will be able to direct rollover your 401k into a Roth IRA and bypassing the unnecessary middle step. Less paperwork makes me a happy camper.
*Restrictions, penalties and taxes may apply. Unless certain criteria are met, Roth IRA owners must be 59 1/2 or older and have held the IRA for 5 years before tax-free withdrawals are permitted.
Photos by Jason York Photography (shameless best friend plug).