Bever Dye LC Attorneys at Law
WICHITA, KANSAS
Roth IRA Contributions and Conversions

As you probably know, the Taxpayer Relief Act of 1997 created a new type of individual retirement account called the Roth IRA. The key benefits of a Roth IRA are that distributions (including distributions of earnings) are tax-free if certain specified conditions are met, you do not have to start taking distributions after you reach age 70-1/2, and you can continue to make contributions even after you reach that age. Your right to make contributions to a Roth IRA is not affected by whether you are an active participant in an employer-sponsored retirement plan. As long as you have earned income and your adjusted gross income (AGI) is below specified limits ($150,000 for married filers, $95,000 for single filers), you can make an annual contribution of $2,000 to a Roth IRA. An overall annual contribution limit of $2,000 per person applies to all IRA accounts. If you contribute $1,000 to a traditional IRA, you may not contribute more than $1,000 to a Roth IRA in the same year. As with a traditional IRA, the deadline for making contributions to a Roth IRA is the unextended due date of your tax return for the year (the following April 15th).

The key disadvantage of a Roth IRA is that you are not allowed to deduct any part of your contribution in computing your taxable income. If you are not able to deduct a contribution to a traditional IRA because your income exceeds specified levels and you are an active participant in an employer-sponsored pension or profit sharing plan, you will benefit from contributing to a Roth IRA instead of to a traditional IRA. If you can deduct your contribution to a traditional IRA, in deciding whether to contribute to a traditional IRA or a Roth IRA, you have to weigh the benefits of an immediate tax deduction for your contribution against the benefits of not having to pay a tax when you make withdrawals. This will depend, in part, on whether you expect to be in at least as high a tax bracket when you start making withdrawals as you are in when you make your contributions.

You should also consider whether you will need to take withdrawals from your IRA after you retire or whether you want to use your IRA primarily to build up an estate for your heirs. If building an estate is your primary concern, you should probably make contributions to a Roth IRA instead of to a traditional IRA.

Another factor to consider is the effect of withdrawals from an IRA on the taxability of your social security benefits. Since withdrawals from a traditional IRA are includible in your gross income, they will increase your adjusted gross income, and thus will probably increase the part of your social security benefits that are subject to tax. On the other hand, the loss of the deduction for a contribution to a traditional IRA may cause an increase in your AGI now, and thus cause you to lose part of certain tax benefits (or deductions) that are phased out when AGI exceeds specified levels.

Qualified distributions from a Roth IRA are tax-free. A "qualified distribution" is a distribution made (1) after a five-year period (which begins with the first year for which a contribution is made to a Roth IRA) and (2) after you attain age 59-1/2, because of your disability, to your beneficiary on account of your death, or distributions of up to $10,000 for certain purchases of a first home.

You can roll over amounts in a traditional IRA to a Roth IRA, or you can convert a traditional IRA to a Roth IRA in any year that your AGI is not more than $100,000. You must, however, include the amount rolled over in your gross income in the year it is distributed from your traditional IRA to the extent that amount is attributable to deductible contributions and earnings. However, the amount rolled over is not subject to any early withdrawal penalty. If the rollover or conversion is made in 1998, a special rule allows you to spread the reporting of the income equally over a four-year period beginning in that year.

Although it is rare for tax advisors to recommend recognizing income earlier than is otherwise necessary, it may be worthwhile to incur the tax cost of rolling over or converting a traditional IRA into a Roth IRA to get the benefits that a Roth IRA offers. Whether this is so will depend on several factors including whether you will need to take distributions from your IRA after you retire, whether you can pay the tax resulting from the rollover or conversion from funds other than funds currently in your traditional IRA, the tax bracket you will be in when you make the rollover or conversion, and the bracket you expect to be in when you have to start taking withdrawals.

The foregoing article has been prepared by Bever Dye, LC, as a service to our clients for informational purposes only and does not constitute legal advice. It is designed to provide general information concerning recent developments and topics of interest in the areas of tax and estate planning law. Do not take action in reliance on items contained in this article without obtaining the advice of an attorney.