Individual Retirement Accounts are investment tools utilized to save money for retirement and enjoy tax benefits. Tax laws change periodically giving access to more individuals allowed to contribute to IRA plans. In 2010 the IRS changed the plans’ rules to allow more investors to open IRAs despite their income and filing status. These rules make it easier to convert to a Roth IRA from a traditional IRA without income limits restrictions.
Income Limits for Roth IRA Contributions
The tax laws consider Modified Adjusted Gross Income (MAGI) and filing status for allowing tax breaks for IRA contributions. This income does not include dividend or investment income. Roth IRA contributions are taxed upfront (not tax deferred). Earnings grow tax free when held for the required time frame. The new 2010 income limits for Roth IRA contributions are as follows:
- Married filing joint return – earned less than $176,000
- Head of Household, Single, Married filing separate – earned less than $120,000
Maximum Income for Traditional IRA
There are no income limits to set up a traditional IRA account. Individuals have to have compensation or income from work to open an account. In a traditional IRA contributions are tax deferred and income taxes are due at the time of distributions. Even though there is no maximum income for a traditional account, the portion of contributions that can be deducted each year for tax purposes is reduced. Income limits for traditional IRA in 2010 when the deduction for contributions may be “phased out” or reduced.
- Married filing joint return – earned between $89,000 and $109,000
- Head of Household and Single Taxpayers – earned between $56,000 and $66,000
- Married filing separate - earned less than $10,000
No Income Limits for Roth IRA Conversions
The conversion rules changed in 2010 for transferring funds from other IRAs to a Roth which has income limits on contributions. Starting with conversions from January 01, 2010 from traditional IRAs to Roth IRAs, income and filing status requirements are eliminated. This means anyone can transfer funds from a non Roth IRA to a Roth IRA without regards to income limits or tax filing status.
The new rules apply to Roth conversions or “transfers” not to new contributions. For new contributions to a Roth income limits and filing status rules apply. Individuals converting from a traditional to a Roth IRA have to pay taxes on the part of the contribution/earnings that were tax deferred and are now withdrawn.
Tips for Income Limits and Conversions: Roth and Traditional IRA
- For individuals with higher incomes (those excluded from Roth participation) it may be beneficial to open a traditional IRA account and later transfer to a Roth.
- Traditional IRA contributions can be deducted from taxes depending on income level; however earnings are taxed at the time of distribution at the future individual’s tax rate.
- Roth IRA earnings grow tax free, no taxes due at the time of distribution if held for the required five years holding period.
- For individuals expecting their income tax rate to go up Roth may be more beneficial than traditional IRAs. This is because Roth contributions are taxed up front and distributions won’t be tax as long as the account holder complies with the plan’s rules. This is assuming a lower tax rate at the time of Roth contribution or conversion.
- Required minimum distribution rules apply to traditional IRAs, Roth have no mandatory distributions.
- There are penalties for early withdrawal of funds from an IRA (non conversions).
Investment Related Resources:
Resources: Public information at the following sites, current as of June 21, 2010.
IRS.gov - publication 590, chapters 1 and 2.
“Get Ready for 2010 – The year of the Roth IRA”, Wall Street Journal online - December 6, 2009.
Sylvia Cruz - Sylvia holds Bachelor and Master degrees in Business Administration with majors in Finance and Accounting. She is also a CIA - Certified ...
