Sure, you have to pay taxes today on the money you put into a Roth. But after that, you pay nothing -- no taxes on growth and no taxes on your withdrawals. And, unless your estate is large enough to get nicked by the federal estate tax, your Roth IRA will pass along to your heirs tax-free.
All that is well and good, but the federal government has laid down strict rules for who can contribute to a Roth IRA, so it pays to know where you stand before you try to put money in.
Roth IRA Contribution Rules
You can only contribute earned income to a Roth or to any other IRA. That means you have to cover your contribution amount with wages from a job or with earnings from self-employment -- capital gains from your stocks, dividends from your bonds or Social Security income won't cut it.
You can also contribute only so much in any given year. Through 2009, the contribution limits are set at $5,000 per year, or $6,000 if you're 50 or over. After that they will be adjusted for inflation.
You also can't contribute, or your contributions limits may be reduced, if you make too much money. This involves calculating your modified adjusted gross income, or MAGI.
We'll get to how to figure your MAGI a bit later. For now, it's important to note that, if you're single, your ability to make a full IRA contribution begins to phase out at $101,000 in MAGI in 2008 and at $105,000 in 2009. For married couples filing jointly, the phase-out begins at $159,000 in 2008 and at $166,000 in 2009.
For singles, contribution limits hit zero at $116,000 in 2008 and $120,000 in 2009. For joint filers, the limit is $169,000 in 2008, and $176,000 in 2009.
Those limits are scheduled to disappear in 2010, but check with your tax adviser or financial adviser before you make a move -- the laws can always change.
Traditional to Roth Conversions
In addition to making annual contributions, you might be able to convert your traditional IRA into a Roth. That, of course, means you will have to pay income taxes on whatever you convert in the year in which you do it. And, in 2008 and 2009, your MAGI cannot be more than $100,000, whether you are a single or joint filer.
That income cap is also scheduled to disappear in 2010, but the same cautions apply.
Calculating MAGI
You should involve a tax counselor to get a precise fix on your MAGI, but here's a way to thumbnail it.
Start with your adjusted gross income -- the bottom line of the front page of your 1040 or 1040A tax return. Then add to that any deductions for IRA contributions, deductions for student loan interest or tuition, employer-paid adoption expenses, any foreign income exclusions and EE savings bond interest used to pay for college.
An online calculator can help you make your IRA decisions.
