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 Stayed at 2009 levels

Contribution limits have stayed at $5,000 for 2010.  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.

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 Limits 2010

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

Roth IRA for College Savings

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.

What you need to know about the Roth IRA for 2010.

That’s the rules of the Roth IRA for 2010.  If you haven’t done so yet, go out an open a Roth IRA and get your tax free nest egg going.  Trust me.  You’ll thank me later that you did

*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).

Securities offered through LPL Financial, Member FINRA/SIPC

Jeff Rose is a Certified Financial Planner and co-founder of Alliance Investment Planning Group.

One of my most favorite questions that I often get as a financial planner is “What’s your best rates on Roth IRA’s?”  Coming in at a close second is, “What’s the best stock to buy right now?” So how would you explain to somebody concerning rates on Roth IRA’s?  Initially, I explain what an I-R-A stands for: Individual Retirement Arrangement (emphasis on arrangement), not Investment that Returns A lot or Interest Rate Account.  I have to admit that I even thought that the “A” stood for account (but was informed by my readers that IRS actually refers to them as “arrangement”.  (Thanks to my readers for keeping me on my toes!) Roth IRA’s don’t pay anything or have interest rates attached to them.   They are just an account – a retirement account.

If this article was helpful, you may also want to check out these posts as well: Roth IRA- Time To Convert ,7 Things You Need to Know About the Roth IRA for 2009, 7 Things to Know About 2010 Roth IRA Conversion.

Roth IRA’s Are Not Investments

The Roth IRA serves as a retirement “account” not a retirement investment. Many people have the belief that IRA’s are like a CD and they pay an interest rate. This is most likely true if you invest in an IRA at your local bank. In this case, you are purchasing a CD within the IRA because CD’s are the only investment option that is available (some banks now do have in house brokerage firms that allow you to put money into other investments).  So in this case, the best IRA rate you can get on your Roth IRA Account is what the going CD rates are.

IRA’s Are The “Investment Vehicle”

photo credit: zen

I have always explained the IRA as your own personal investment vehicle. You then choose what passengers go inside your vehicle. The mental image of the clowns at the circus piling into the little car always comes to mind. You can have as many clowns in your IRA as you want to as few as you want. You could have all your money invested into Walmart stock or spread out across 100 different stocks (You would have to have a substantial amount of money in the IRA to do this).

If you open an Traditional or Roth IRA at a brokerage firm, you may invest into CD’s just like at your local bank, but you also open the door to many other investment choices. Then what your IRA pays is determined on the actual return of that investment.  If you had invested into the stock market in 2008, the your Roth IRA probably paid closer in the -30% range.   (Ouch!)

Don’t Ask What the Best Roth IRA Rate Is

So when somebody does ask me, “What is your best Roth IRA rate?”, I respond simply with “Depends”.  Then wait for the confusion to set in

Securities offered through LPL Financial, Member FINRA/SIPC

Jeff Rose is a Certified Financial Planner and co-founder of Alliance Investment Planning Group.