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Funding an IRA
A Roth IRA can be funded from several sources:
Roth IRA Participant Contributions
Every year, an individual may contribute 100% of compensation up to the following amounts:
Tax Year
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Regular Contribution Limit
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Tax Year
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Additional Catch-Up Contribution Limit
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2004
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$3,000
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2004
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$500
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2005
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$4,000
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2005
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$500
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2006
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$4,000
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2006
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$1,000
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2007
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$4,000
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2007
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$1,000
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2008
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$5,000
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2008
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$1,000
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2009 and after
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$5,000
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2009 and after
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$1,000
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Beginning 2009, contributions are indexed
for cost-of-living adjustments (COLA)
increases in $500 increments.
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Catch-up contributions are not indexed for inflation. |
Table 1 - Roth IRA Contributions Limits
Individuals who are age 50 and older by the end of the year for which the contribution applies can make additional catch-up contributions. For instance, an individual who is under age 50 may contribute up to $4,000 for tax year 2007, but an individual who reaches age 50 by year-end 2007 may contribute up to $5,000.
All IRA participant contributions must be made in cash (which includes checks), so Roth IRA participants cannot make contributions in the form of securities.
Spousal IRA Contribution
An individual may establish and fund a Roth IRA on behalf of his/her spouse who makes little or no income. Spousal Roth IRAs are subjected to the same rules and limits as that of regular Roth IRA participant contributions. The spousal Roth IRA must be held separately, as Roth IRAs cannot be held as joint accounts.
In order for an individual to be eligible to establish a spousal Roth IRA, the following requirements must be met:
- The couple must be married and file a joint tax return.
- The individual making the spousal Roth IRA contribution must have eligible compensation.
- The total contribution for both spouses must not exceed the taxable compensation reported on their joint tax return.
- Contributions to one Roth IRA cannot exceed the contribution limits as detailed in the above chart.
Transfers
A transfer is a non-reportable, nontaxable movement of assets between similar types of retirement plans. A Roth IRA owner generally transfers assets between Roth IRAs for the purpose of consolidating assets or changing financial institutions.
A transfer of Roth IRA assets may also be made from one spouse's (or former spouse's) Roth IRA to another, providing the transfer is permitted in accordance with a divorce decree or a legal separation agreement.
There is no limit on the number of times an IRA holder may transfer assets between Roth IRAs.
Rollovers
An individual may make rollover contributions to his or her Roth IRA. A rollover is a tax-free movement of assets between retirement plans, but unlike a transfer, the transaction is reportable: the distribution is reported to the IRS and IRA owner on Form 1099-R, and the rollover contribution is reported on Form 5498. An IRA owner may complete one rollover contribution per IRA within a 12-month period.
A rollover contribution may originate from a distribution from the same Roth IRA or another Roth IRA. Rollover contributions must be made within 60 days after the Roth IRA owner receives the distributed assets.
Conversion
A conversion is a taxable and reportable movement of assets from a Traditional, SEP or SIMPLE IRA to a Roth IRA. SIMPLE IRA assets cannot be converted to a Roth IRA until two years after the employer first made a contribution to the individual's SIMPLE IRA. (See the tutorial SIMPLE IRAs for details).
The conversion is reported to the IRS and IRA owner on IRS Form 1099-R (for the Traditional IRA) and IRS Form 5498 (for the Roth IRA). There is no limit on the number of conversions an individual may complete within any period. However, individuals with a modified adjusted gross income (MAGI) of more than $100,000 or individuals who are married and file separate tax returns are not eligible for a Roth IRA conversion.
Reconversions
An individual who converts Traditional, SEP or SIMPLE IRA assets to a Roth IRA may have that conversion nullified by recharacterizing the conversion. The individual may then later decide to convert the assets back again to a Roth IRA. The second conversion of these assets is a reconversion, which must not occur before the later date of these two following times:
- the beginning of the tax year following the taxable year in which the first conversion occurred
- 30 days after the recharacterization occurs
Any reconversion that occurs before the later of these two dates is treated by the IRS as a failed conversion and must be returned to the Traditional IRA by means of a recharacterization.
An Example
Tom, whose annual compensation is $90,000, converted his Traditional IRA to his Roth IRA in Jan 2004. He receives a bonus of $20,000 in Nov 2004, which brings his compensation to $110,000. Tom's MAGI is now over the $100,000 threshold, and he is therefore not eligible for a Roth conversion for tax year 2004. Tom recharacterizes his conversion (back to his Traditional IRA) on Dec 1, 2004.
Tom may reconvert his Traditional IRA to his Roth IRA anytime on or after Jan 1, 2005 for the following reasons:
- Jan 1, 2005, is the beginning of the year following the year he first converted his IRA assets.
- Jan 1, 2005, is later than 30 days after he recharacterized the conversion.
The following are examples of dates on which Tom would be eligible to reconvert his Traditional IRA to his Roth IRA, as determined by the date he recharacterized the conversion:
Date of Conversion
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Date of Recharacterization
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Earliest Date Eligible for Reconversion
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Comments
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Jan 31, 2003
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June 30, 2004
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Jan 1, 2005
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This is later than 30 days after the recharacterization. |
Aug 31, 2004
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Oct 15, 2005
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Nov 15, 2005
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This is later than the first day of the year following the year the conversion occurred. |
Dec 31, 2004
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July 15, 2005
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Aug 15, 2005
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This is later than the first day of the year following the year the conversion occurred. |
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Recharacterization
A recharacterization is the act of treating an IRA contribution as one being made to another type of IRA, or, as discussed above, a recharacterization is a reversal of a conversion to a Roth IRA. An individual who makes a contribution to a Traditional IRA may later decide to treat this contribution as a contribution to a Roth IRA (or vice versa). The assets representing the contribution, along with any earnings or without any loss are moved from the Traditional IRA to the Roth IRA. The transaction is not taxable, but it is reportable.
Recharacterizations must be completed by the individual's tax-filing deadline (generally Apr 15 of the next year) for the year the contribution or conversion occurred. If, however, the individual either files a tax return by the tax-filing deadline or applies for a tax-filing extension by the tax-filing deadline, the deadline for the recharacterization is automatically extended for an additional six months (usually to Oct 15).
Deducting IRA Contributions
Roth IRA contributions are not deductible; therefore, unlike a Traditional IRA contribution, a Roth IRA contribution is not affected by an individual's active-participant status.
Tax-Filing Requirements
Roth IRA participant contributions are not required to be reported on the individual's income tax return. However, the IRA holder may be required to report Roth IRA conversions, recharacterizations and distributions on his or her tax return.
Permissible Investments in IRAs
One benefit of investing in a Roth IRA is that the investment options are many and varied. There are relatively few investments that are not permitted in a Roth IRA. The ability of the Roth IRA owner to choose the type of investment depends on the Roth IRA product and the financial institution. Some Roth IRAs may be limited to a pre-selected core group of investments or to a specific investment. For others Roth IRAs, the owner is free to choose the investments. These are commonly referred to as "self-directed Roth IRAs" (SDAs).
Permissible investments for IRAs include stocks, bonds, mutual funds, real estate, some coins and money market funds.
Investment in Collectibles
Roth IRAs cannot invest in collectibles, which include art works, rugs, antiques, metals, gems, stamps, coins, alcoholic beverages and certain other tangible personal property. The exceptions are U.S. gold coins, silver coins minted by the Treasury Department, certain platinum, gold, silver, palladium, and platinum bullion. Volume limitations apply.
Some financial institutions place further restrictions on Roth IRA investments.
Next: Roth IRAs: Distributions
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