Roth Individual Retirement Accounts (IRAs) do not enable you to take tax deductions for your contributions, but can enable you to receive tax-free earnings and tax-free withdrawals. To start a Roth IRA, you must meet income limits. Roth IRAs limit the amount of money you can contribute each year, but do not limit the age at which you can make contributions. You can start a Roth IRA by rolling over funds from a 401(k) account or traditional IRA, but may face tax consequences as a result of a conversion.
Starting a Roth IRA
You must meet income limits to qualify for a Roth IRA. As of August 2011, your taxable compensation and modified adjusted gross income (AGI) must be less than $177,000 if you are married and filing jointly with your spouse or you are a widow or widower. You can only have taxable compensation and a modified AGI less than $120,000 if you file as the head of your household or as a single person. If you are married, live with your husband or wife and file separately, you can open a Roth IRA only if your taxable compensation and modified AGI fall below $10,000. Your taxable compensation can include your salary, wages, bonuses, professional fees or tips. Your modified AGI is your taxable compensation, after exclusions and deductions.
You cannot take a tax deduction for contributions you make to a Roth IRA. The amount of money you can contribute to a Roth IRA can depend on your income and age. For example, as of August 2011, if you have taxable compensation and modified AGI less than $167,000, you can contribute only $5,000 annually if you are younger than 50 years of age. The limit increases to $6,000 if you are 50 years old or older. While Roth IRA rules may restrict the amount of funds you can contribute at a certain age, you can continue to make deposits even after you reach retirement age.
If you open a Roth IRA by converting funds from a traditional IRA, you can face tax liability on any income earned from the traditional IRA before converting it to a Roth IRA. Beginning the 2010 tax year, the IRS began allowing investors who roll over funds to Roth IRAs to pay taxes resulting from conversions over a two-year period. This enables you to divide your earnings and minimize your tax liability during a single year. Once you pay taxes on the converted funds, the IRS does not levy any additional taxes on a Roth IRA. If you choose to convert from a 401(k) plan to a Roth IRA, the same tax rules apply.
You can withdraw money from your Roth IRA contributions at any age tax-free and with no penalty. You can also take a withdrawal that includes contributions and earnings without penalty or tax liability if you hold your Roth IRA for at least five years. To qualify for penalty-free and tax-free earnings withdrawals you must be over the age of 59 1/2, need the funds due to a disability or death or need funds to purchase your first home.