What to consider when considering a Roth IRA
- By Milt x_Zall
- Mar 16, 2000
A Roth IRA provides a great deal of flexibility when you're planning for
retirement. Contributions to the account are made after taxes, but growth
of the account is tax-free. However, to truly realize its benefits you must
know what you can do with the Roth IRA — and when you can do it.
Here's a rundown of the Roth IRA contribution and conversion rules.
Contributions: As a federal worker participating in the Federal Employees
Retirement System or Civil Service Retirement System, you are still eligible
to contribute to a Roth IRA. You can contribute up to $2,000 a year to a
Roth IRA or the amount of your taxable compensation, if it's less. The amount
you can contribute to a Roth IRA is reduced by the amount you may have already
contributed to another IRA. In addition, if your modified adjusted gross
income (MAGI) exceeds $95,000 as an individual or $150,000 for joint filers,
then you are limited as to how much you can contribute to a Roth IRA.
Conversions: If you have an existing traditional IRA, you can convert
it to a Roth IRA if your MAGI does not exceed $100,000, and you file a joint
return if you are married. You can convert to a Roth IRA at any time.
To convert, you would withdraw the traditional IRA balance and, within
60 days, deposit it into a Roth account, or you would transfer the funds
from one trustee to another. If the trustee remains the same, the traditional
IRA can simply be re-designated as a Roth IRA. The amount converted will
be considered taxable income in the year of the conversion.
For example, assume you have a traditional IRA with a value of $50,000.
You re-designate the account as a Roth IRA on Dec. 15, 1999. The $50,000
amount is treated as a 1999 taxable IRA distribution. Re-characterization:
A re-characterization, or correction, involves moving assets from one type
of IRA to another (Roth to traditional or vice versa). There are three re-characterization
1. A contribution to a Roth is re-characterized as a contribution to
a traditional IRA.
2. A contribution to a traditional IRA is re-characterized as a contribution
to a Roth.
3. A conversion from a traditional IRA to a Roth is reversed. The conversion
is treated as if it were never made.
Timing: If a re-characterization is made by the tax return due date,
including an extended due date, for the year in which it was made, the contribution
made to the first IRA is treated as if it had been made to the second IRA
on the same date. The re-characterization is reported on your tax return
for the year in which it occurred.
For example, if you decide that converting your traditional IRA to a
Roth in 1999 was a bad idea, you can re-characterize your 1999 conversion
by April 17, 2000, or later if you get a 1999 return filing extension. If
you file your 1999 return by April 17, 2000, without re-characterizing the
conversion but then decide to re-characterize your 1999 conversion, you
still have until Oct. 16, 2000 to do so.
An IRS Form 8606 must be attached to the tax return, along with a statement
explaining the circumstances of the re-characterization. If you re-characterize
a conversion after filing your tax return, you must file an amended return
with the annotation "Filed pursuant to section 301.9100-2" and may have
to file an amended Form 8606.
Re-conversion: Changing your mind more than once in the Roth IRA context
is called re-conversion. Effective Jan. 1, 2000, if you convert a traditional
IRA to a Roth and then back to a traditional IRA through a re-characterization,
you can't reconvert to a Roth until the tax year following the year in which
the transfer occurred or 30 days following the re-characterization, whichever
is later. This rule is intended to discourage people from capitalizing on
a decline in the value of the IRA's portfolio by reducing tax liability.
Note that if you converted to a Roth in 1999 and re-characterize the conversion
in 2000, you can still reconvert back to a Roth in 2000 if it's done at
least 30 days later.
Although Roth IRA re-conversions have gotten tougher, they remain a
worthwhile strategy. Many people are finding that a tax-free annuity for
themselves and their beneficiaries is worth paying up-front conversion taxes.
When stock market changes invite them to reduce those conversion taxes through
re-conversions, so much the better.
—Zall is a free-lance writer based in Silver Spring, Md., who specializes
in taxes, investing and business issues. He is a certified internal auditor
and a registered investment adviser. He can be reached via e-mail at [email protected]
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