Roth IRA planning.
Author/s: Gary R. Stout
Issue: August, 1998
How can clients achieve the maximum benefits from this new retirement saving
vehicle?
If cash for retirement savings is limited, taxpayers should fund their Roth IRAs
before making maximum contributions to their 401(k) plans.
The highly publicized Both IRA, created by the Taxpayer Relief Act of 1997, is
familiar to most CPAs. The new retirement saving vehicle became available after
December 31, 1997, under new IRC section 408A. Roth IRAs offer clients a third
option in addition to deductible and nondeductible IRAs. Many clients with IRAs must
decide whether they should convert those accounts to Roth IRAs and pay tax on
them now. Others must decide what type of IRA to contribute to in 1998. This article
explains the available options and provides a worksheet CPAs can use to help clients
make the right choice.
THE OLD LAW
Under prior law, taxpayers could deduct contributions to IRAs in computing their
adjusted gross incomes if they were not active participants in employer-sponsored
retirement plans or if their incomes were below specified levels. Contributions were
partly deductible for active participants whose incomes fell within a specified phase-
out range. Taxpayers ineligible to make deductible contributions could make
nondeductible contributions. Total contributions (deductible and nondeductible) for a
tax year could not exceed the greater of $2,000 or earned income. Earnings on IRA
contributions (deductible or nondeductible) were includable in gross income only
when distributed. A taxpayer was required to begin IRA distributions by April 1 of the
year after he or she attained age 70 1/2, subject to a minimum distribution excise
tax. Distributions to beneficiaries generally were required to begin within five years
of the IRA owner's death. Taxpayers could not make IRA contributions after age 70
1/2.
THE 1997 ACT AND ROTH IRAs
Except as described below, a Roth IRA (a section 408A IRA) is treated the same as a
conventional IRA (a section 219 IRA). While contributions to a Roth IRA are
nondeductible, distributions are tax-free after age 59 1/2 if the account is at least
five years old.
Contributions and AGI limitations. A Roth IRA must be designated as such by the
taxpayer at the time it is established. After 1997, an individual can make an annual
nondeductible contribution to a Roth IRA equal to the lesser of $2,000 or 100% of
his or her compensation, minus any contributions for me tax year to an other non-
Roth IRAs. This means the total annual contributions to all three types of [RAs
cannot exceed $2,000. For higher income individuals, the allowable contribution is
phased-out pro rata for single taxpayers with AGIs of $95,000 to $110,000 and for
married taxpayers filing jointly with AGIs ranging from $150,000 to $160,000. Under
section 408A (c) (3) (C) (ii), the AGI limit for married taxpayers filing separately is
zero. This means they cannot make contributions. These AGI limitations apply
without regard to whether a taxpayer actively participates in an employer-sponsored
retirement plan.