The Taxpayer Relief Act of 1997 created the ROTH IRA effective January 1, 1998. Although ROTH IRA’S are not tax deductible, if certain requirements are met, the earnings can be withdrawn tax free. Furthermore, the so-called “minimum distribution rules” that apply to Traditional IRA’S do not apply to ROTH IRA’S. Traditional IRA’S require withdrawals no later than April 1 following the Calendar Year in which the owner reaches age 70 ½ . Earnings in a ROTH IRA can accumulate tax-free during the owner’s lifetime.

Joseph D. Cataldo
By Joseph D. Cataldo

Joseph D. Cataldo is an estate planning/elder law attorney, Certified
Public Accountant, registered investment advisor, AICPA Personal
Financial Specialist and holds a masters degree in taxation.

(617) 387-3793

An individual can contribute the lesser of his or her earned income for the year or $4,000 to either a ROTH IRA or a Traditional IRA. The Taxpayer, however, must meet certain adjusted gross income (AGI) limitations. In addition, the owner may still participate in an employer-sponsored retirement plan.

For single Taxpayers, eligibility phases out with AGI between $99,000 and $114,000 and for married, filing joint Taxpayers, eligibility phases out with AGI between $156,000 and $166,000.

For a married, filing joint Taxpayer, if the couple’s AGI is less than $156,000, and the working spouse has at least $8,000 in earned income, then each spouse can contribute $4,000 to a ROTH IRA.

A Traditional IRA can be converted into a ROTH IRA, in whole or in part, if, for both single Taxpayers and married, filing jointly Taxpayers, their AGI is less than $100,000, not including the amount of the taxable conversion itself.

Why contribute to a ROTH IRA? The benefits of “tax-free” earnings are simply too good to ignore. You may, however, still decide to contribute to a Traditional IRA if you (i) expect to retire relatively soon; (ii) you expect that your tax bracket will significantly drop during retirement; (iii) you will need the funds soon; (iv) and you plan on investing the savings in tax dollars generated from the Traditional IRA contribution itself.

If one is able to contribute the maximum amount to his or her 401(k) plan or 403(b) plan, or if one is laid off, switches jobs or simply retires, tremendous flexibility is gained when viewing basic ROTH IRA planning. When you terminate your employment, your 401(k) balance, for example, can be rolled over first into a Traditional IRA “roll-over” account. This would constitute a tax-free “roll-over.” From there, you could convert the Traditional IRA to a ROTH IRA. This would constitute a taxable conversion. You have the flexibility of determining in which Calendar Years to perform the conversion, based upon whether or not you had been working in a particular Calendar Year, whether or not your other income is usually low in a particular year, or whether or not you had sufficient mortgage interest or real estate tax deductions to help offset the “conversion” income.

One problem with Traditional IRA’S is that the “deferred income” is ultimately taxed to the beneficiaries. With ROTH IRA’S, the income when received is received “tax free.” Furthermore, tax-free growth can continue after your death unlike with a Traditional IRA. Although non-spouse beneficiaries must take minimum distributions from an inherited ROTH IRA, with respect to the remaining balance in the ROTH IRA account, tax-free growth still exists.

Children old enough to earn income should be encouraged to earn at least $4,000 per year in order to contribute to a ROTH IRA. This will result in a tremendous benefit based upon many years of contributions. The investment accumulates income tax free.

One often overlooked benefit of a ROTH IRA is found in the Medicaid Planning area. An individual who foresees the possibility of being admitted into a nursing home, expecting to apply for Medicaid benefits, could make a qualified distribution to a child from the ROTH IRA account without incurring the otherwise substantial income tax that would have been generated if the monies were housed in a Traditional IRA account. Once the required five-year look back period is satisfied, that individual may be eligible for Medicaid benefits as a result of having transferred the countable ROTH IRA assets from his or her estate.

ROTH IRA’S offer significant planning opportunities. If you are eligible to make a contribution, it is almost always a good idea to do so. A ROTH IRA contribution must been made by April 15, 2008 for Calendar Year 2007.