Roth IRA accounts and Roth 401(k) and 403(b) plans offer the same basic structure: after-tax contributions and tax-free withdrawals. But there are some distinct IRS rule differences that affect how you can contribute to each account and how you take distributions in retirement.
To contribute to a Roth IRA, your modified adjusted gross income, MAGI, must be under certain levels -- $122,000 for unmarried persons in 2011 and $179,000 for married persons filing a joint tax return. For a full Roth contribution, the MAGI limit for singles is $107,000 and $169,000 for couples. There are no IRS income limits for Roth 401(k) contributions. If you're eligible for your employer's program and a Roth option is available, you can make a full contribution.
The most you can contribute to a Roth IRA is $5,000 -- plus another $1,000 if you're over age 50. You can contribute $16,500 to a Roth 401(k) with a catch-up contribution of $5,500 more if you're at least 50.
Conversions And Recharacterizations
After you make an after-tax contribution to a Roth IRA or you convert all or a portion of a traditional IRA into a Roth, you have until your tax-filing deadline to "recharacterize" the transaction. That means you can change a contribution into a tax-deductible IRA contribution -- assuming your income level allows it. Or, you can reverse all or part of the conversion, eliminating or reducing your tax liability. Any transaction into a Roth 401(k) is irrevocable. You can't recharacterize it as a regular tax-deductible 401(k) contribution, nor can you send a conversion back to your regular 403b to avoid a tax hit.
Five-Year Holding Period
For both a Roth IRA and a Roth 401(k), you must hold the account for five years before you can withdraw any of your earnings. The five-year clock for Roth IRAs begins on the first day of the year for which the contribution was made. For example, if you made a Roth contribution for 2010 on April 15, 2011, the day you filed your 2010 taxes, your required holding period started Jan. 1, 2010. Any subsequent Roth IRA account -- or contribution -- gets the same beginning date. For a Roth 401(k), the five-year holding period also begins the first day of the year in which the account is opened. But subsequent accounts don't inherit that date. If you switch employers and open a new Roth 401(k), each account has its own five-year clock. One exception: You keep your original five-year starting date if you roll your Roth 401(k) from your old employer into your new company's plan. If you roll over a Roth 401(k) into a Roth IRA, you inherit the starting date for the IRA account -- not the one for the Roth 401(k). So, if the rollover is into a new account, you must wait five years before you can withdraw any of your earnings.
You can withdraw contributions -- just not any earnings -- from a Roth IRA any time for any reason without penalty or tax consequences. But even after you meet the five-year test, you must be at least age 59½ or disabled to qualify for a tax-free distribution of earnings. If you take a nonqualified distribution from a Roth IRA, though, you can pull out contributions tax-free first. Not so for a Roth 401(k). In many employer-sponsored plans, you can't take a distribution -- except for specified emergencies -- while you're still working at the company. Plus, part of any nonqualified distribution might be taxable, based on the proportion of the account that is considered earnings.
There are no required minimum distributions for a Roth IRA. However, the required distribution rules that apply to traditional IRA accounts do apply to workplace retirement plans, including Roth 401(k) and Roth 403(b) accounts. This doesn't have to be a significant problem; simply roll over the Roth work plan into a Roth IRA when you retire. Because of the five-year holding period, though, it pays to establish at least a small Roth IRA account early to receive the rollover.
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