Beginning for tax years after 1997, a new IRA is available to taxpayers.
The "Roth" IRA was established by the Taxpayer’s Relief Act of 1997. Generally, an individual may make an annual, non-deductible contribution to a Roth IRA up to the excess of: (1) the lesser of $2,000.00 or 100% of the individual’s annual compensation over (2) the aggregate amount of contributions for the tax year to all other IRAs (other than Roth IRAs) maintained for the benefit of that individual [IRC Section 408A(c)(1) and (2)].
The contribution is phased out as an individual’s adjusted gross income exceeds certain dollar amounts.
The phase out for an individual reduces the maximum contribution by the same ratio as the amount of the excess of the taxpayer’s adjusted gross income for the tax year exceeds $95,000.00, bears to $15,000.00. The phase out for an individual would be complete at $110,000.00.
For joint filers, the phase out reduces the maximum contribution by the same ratio as the amount of the excess of the taxpayer’s adjusted gross income for the year over $150,000.00, bears to $10,000.00. Thus, the phase out is completed for joint taxpayers at $160,000.00 of adjusted gross income.
A taxpayer filing married but separately is not permitted to make a contribution to a Roth IRA.
Distributions from a Roth IRA will be qualified and, therefore, tax and penalty free five (5) tax years after the contribution, if the distribution is: (1) made on or after age 59-1/2 or death, (2) made on account of disability or (3) used for qualifying first-time buyer expenses.
The five year holding period is defined by tax years rather than five calendar years. Therefore, the actual holding period may be less than five years.
For rollovers, the five year period will begin in the tax year in which the rollover is made. Rollovers may be made to a Roth IRA from non-deductible and deductible IRAs. However, no rollover is permitted if the taxpayer’s adjusted gross income for the year exceeds $100,000.00 or the taxpayer is a married individual, filing separately.
A rollover to a Roth IRA is treated as a taxable distribution. If the rollover is a qualified rollover (within sixty days), there is no early withdrawal penalty.
If a taxpayer makes a qualified rollover from non-Roth IRAs or converts non-Roth IRAs to Roth IRAs before January 1, 1999, he is eligible to spread out the tax resulting from the distribution ratably over a four-year period. Again, to qualify for this ratable extension of time to pay the taxes on the conversion, the taxpayer’s adjusted gross income may not exceed $100,00.00 and he or she may not file using married but filing separate status.
Excess Contributions to a Roth IRA are subject to a 6% tax under IRC Section 4973.
An excess contribution to a regular IRA can be transferred to a Roth IRA before April 15th of the following tax year and will not be includible in gross income if no deduction was allowed for the contribution. Contributions may be made to a Roth IRA even after the owner is age 70-1/2. As with other IRAs, contributions for the preceding year may be made up to April 15th of the succeeding year.
Qualified distributions from a Roth IRA, as described above, are not includible in income.
If the distribution is not "qualified", the distribution may still be non-taxable.
Distributions from Roth IRAs are considered to have been made first from returns of contributions and then from income on the contributions. Because the return of contributions is considered to be in the aggregate, a taxpayer may prematurely withdraw the contributions he has made to the Roth IRA without tax or penalty. There are no minimum distribution rules before death and the Roth IRA is not subject to the incidental death benefit rules of IRC Section 401 (A).
A beneficiary of a Roth IRA can make an early withdrawal from the IRA for the first time purchase of a home without penalty. This home withdrawal is limited to $10,000.00 over the taxpayer’s lifetime. This provision is found in IRC Section 72(t)(2)(F) and actually applies to all IRAs.
The distribution must be a "qualified first time home buyer distribution." This is a distribution received by an individual which is used for the payment of "qualified acquisition costs" for the "principal residence" of a "first time home buyer."
The distribution must be made before the close of the 120th day after the day on which the payment or distribution is received to pay "qualified acquisition costs with respect to a principal residence of a first time home buyer who is such individual, the spouse of such individual, or any child, grandchild or ancestor of such individual or the individual’s spouse." [IRC Section 72(t)(8)(A)].
The Act defines "qualified acquisition costs" as the costs of "acquiring, constructing, or reconstructing a residence. Such term includes any usual or reasonable settlement, financing or other closing costs."
A first time home buyer is defined as an individual (and, if married, such individual’s spouse) who over a two year period has had no present ownership interest in a principal residence, beginning on the date of the acquisition of the principal residence acquired by the home buyer.
A principal residence is defined as a residence which was the primary residence of the home buyer for two out of the last five years as defined under IRC Section 121(a).
The Code also defines the date of acquisition as either the date on which a binding contract to acquire the principal residence was entered or the date upon which construction or reconstruction commenced [IRC Section 72(t)(8)(D)]. If there is a delay in construction or acquisition of the residence which would cause the distribution to fail to meet the requirements of the 120 day rule, the distribution may be re-contributed to the IRA within the same 120 day period without penalty.
The Roth IRA contribution makes sense for any taxpayer.
Certain commentaries have concluded that if you expect to be in a tax bracket equal to or greater than your current tax bracket at the time of distribution, a Roth IRA may not be an attractive investment vehicle. However, it seems to the author that, generally, a taxpayer can expect to be in a lower tax bracket at the time of distribution and the tax free distribution of income from investments will be of greater benefit to the IRA holder than the maximum $2,000.00 deduction which is available to the taxpayer.
The conversion of non-Roth IRAs to Roth IRAs is especially advantageous during 1998. The ability to earn tax-free income from your contribution while spreading the tax incurred from the distributions over a four-year period should result in the earnings exceeding the tax imposed upon the rollover.
Anyway you look at it, the Roth IRA is a "super" IRA for taxpayers.
Joel D. Arnold is a Principal of Fortunato, Farrell, Davenport & Arnold, Ltd., Westmont. His practice is concentrated in Taxation. He received his Undergraduate Degree in 1970 from North Park College, his Law Degree in 1973 and his LLM in Taxation in 1984 from John Marshall.