8 things you need to know about a Roth IRA for 2008
By CHM on Jan 11, 2008 in Featured, Roth IRA Conversion, Roth IRA Rules
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I firmly believe most GenXer’s should make the Roth IRA the cornerstone of their future retirement plans.
In my opinion, over the next 10-15 years the Roth IRA and Roth 401(k) will quickly become the backbone for retirement planning in this country.
For Americans under the age of 45 you should put the wheels in motion to incorporate the Roth IRA into your plans ASAP; and for those over the age of 45, I strongly recommend taking a close look at how adding (or converting to) a Roth IRA may add a whole new dimension to your future plans.
(I’ll probably spend the next few days writing about the Roth IRA. While writing this piece, I experienced a surge of new ideas that inspired me to scribble down an abundance of Roth related post ideas that, undoubtedly, will beef up that section of my tag cloud. Happiness is…)
Out with the old, in with the new
For me, it felt like 2007 came and went in the snap of a finger, and then from no where, 2008 was thrust upon us. So, with the simple stroke of a clock, much of the time sensitive information on the world wide web became outdated overnight.
With that in mind, I broke into a cold sweat and didn’t know what to do about those of my posts that were rendered impotent in the blink of an eye…
First, I thought of taking a few of my Roth IRA posts from 2007 and vigorously updating the information to reflect the new numbers for 2008, breathing new life into their sagging font(s). But instead I think (for now) I’ll just highlight 8 things you need to know about the mighty Roth IRA for 2008:
The annual contribution limit for 2008 has gone up to $5,000. If you are over the age of 50, the contribution limit has gone up to $6,000. If you are making monthly contributions (which I like) then you will be adding $416.66 a month ($5,000/12). In my parents case (which I have documented) they will each be making a $6,000 contribution for 2008. Which reminds me I have to bring the contribution forms over to the house.)
If you’re thinking about doing a large Roth IRA conversion soon, consider waiting until 2010 before pulling the trigger, that way you can spread the tax bite over two years. Investors who plan to do a conversion in 2010 have 4 years (2008-2011) to accumulate the funds necessary to pay the income taxes on the conversion.
If you convert to a Roth IRA in 2008, all the taxes you owe will be due by next April’s tax filing. If you wait to convert, in 2010 Uncle Sam is giving you til 2012 to come up with those taxes. Plus, by waiting, it allows you to plan the whole event out better.
Beginning in 2008, a participant under an employer’s qualified plan 401(k), section 403(b), or government 457(b) who is receiving an eligible rollover distribution may elect to convert the distribution directly to a Roth IRA without having to first roll it over to a traditional IRA.
Prior to 2008, the only source of a conversion to a Roth IRA was a conversion from a traditional-type IRA. From an administrative standpoint, by eliminating this middle step, it makes it that much easier to get with the program.
This is actually a very subtle but important improvement. You’d be surprised how often paper work complications and admin. issues have stopped people dead in their tracks. I can’t tell you how many times I’ve seen investors discouraged from following through on making the right decision, solely because of the back office headache.
A simple change like this, that uncomplicates things, is a God sent and should bolster the numbers of Americans that can call themselves ‘Roth IRA Owner’.
At any time, the owner of a Roth IRA may withdraw up to the total amount of his (or her) contributions, not to be confused with the total amount in the account. The entire amount can only be taken tax free if the distributions are qualified.
If you’re just getting started in planning for retirement, in my opinion, the Roth IRA should be the first place you invest your dollars, even before you open a regular investment account or contribute to a workplace retirement savings plan.
The only exception is if your employer offers a match on your 401(k) contributions. This whole section (#5) is predicated on the fact that you meet the eligibility requirements to fund a Roth IRA, if you don’t meet the eligibility requirements all hope is not lost, keep reading…)
For 2008, if you may make too much money to contribute to a Roth IRA, (To find out if you are eligible click on this post I recently updated, which is current for 2008.) you shouldn’t be discouraged from exploring other ways to own a Roth IRA, eventually.
Although there are income restrictions that disallow certain high wage earners from making normal, upfront contributions, there are no rules that say you can’t come in the backdoor. By making a non-deductible contribution to a regular IRA in 2008, you will be able to convert this year’s contributions to a Roth IRA in 2010 or later.
A conversion to a Roth IRA may be reversed or undone without penalty by transferring the funds and any earnings back to a traditional IRA before the due date for the tax return. I figured it’s important to throw this in, although I hope you never have to make that decision.
Although this last one is not pertinent for 2008, I’m asked about it all the time and feel the need to get it off my chest. A common misconception many people have, about converting to a Roth IRA, has to do with the repeal of the AGI (adjusted gross income) limitation in 2010.
Let’s see if I can break it down in plain English. Starting in 2010 it won’t matter how much money you make, you will be able to convert any pre-existing retirement plans to a Roth IRA; where as before you couldn’t if you made over $100,000. The key words here are “convert any pre-existing retirement plans.”
What that means is you can convert old retirement plans until your hearts content, but still may not be eligible to contribute new monies to a Roth IRA. To make normal, yearly Roth IRA contributions you will still have to earn under the phaseout limits, which are not being repealed in 2010.
This is probably confusing, so let’s go to an analogy:
Let’s say the year is 2010 and Thomas Plumtree, a single taxpayer, has AGI of $195,000. He has a traditional IRA worth $70,000. Tom has been dying to convert to a Roth IRA and now he can, because his income no longer restricts him from doing so.
Unfortunately, he can’t go ahead and make a new Roth contribution for 2010 because his income is still too high, restricting him from doing so. The moral of the story is: you can convert pre-existing accounts to a Roth in 2010, but won’t be able to add new monies.
But I wouldn’t worry about it too much, if you’re committed to the process, you can always do the Texas two step and backdoor your way in, as detailed in point #6.
In Conclusion
I apologize if I temporarily dazed you with my somewhat dramatic overuse of the English language at various points throughout the post. Sometimes I try and breath fiery life into these somewhat dry, albeit, vital topics.
And besides, it’s late here in NYC and I just watched an episode of ‘Family Guy’ with a heavy concentration of Stewie:)
This post was featured in:
- The Carnival of Personal Finance #135 hosted by Plonkee Money. For more information please visit the Carnival of Personal Finance.
Tags: 2008 Roth IRA Rules, 2010 Roth IRA Conversion Event, Roth IRA Conversion
rickshaw | Jan 13, 2008 | Reply
CHM,
When is the ‘deadline’ to contribute to a 2007 Roth?
CHM | Jan 13, 2008 | Reply
Rick,
Tax filing deadline, April 15th 2008.
Velvet Jones | Jan 13, 2008 | Reply
Hi there. I came across your blog last month and bookmarked it. I’m hoping this site will be one of the tools I used to help me understand investing more, as that’s a goal for me this year.
You mentioned in this post that you like making monthly Roth contributions. In your professional opinion, do you believe this is better than making a lump sum contribution? I wondering if I should make a monthly contribution or save up the full amount by April and make a full contribution then. There’s a lot of information supporting both sides and I’m conflicted on which would be best for me. Any insight you can share would be appreciated. Thanks!
CHM | Jan 13, 2008 | Reply
Velvet,
Like you said, there are a lot of opinions supporting both sides, so neither way is wrong.
With that said, I’d recommend making monthly contributions, I’m a big fan of dollar cost averaging or making systematic type investments.
That way if the market is up, you’re buying less at higher prices, if the market is down, you’re buying more at lower prices. In essence, there’s a built discipline that will reward you in the long run. (I’m going to write a post about this soon, with supporting evidence.)
I’ve read on other blogs recently, people excited to get all their money in right now while the market has been hit, maybe that will work, but at the end of the day they’ve made a decision to try and time the market (year after year), a losing proposition and a losing mindset to adopt.
To be a successful investor in the longrun, you need to learn to understand your emotions and be somewhat unemotional about your investment decisions. And this is most easily accomplished by averaging in monthly (quarterly, etc.)
Also, you won’t wallop your cash flow by moving in over the course of the year, I’d recommend automating the deposit; that way you won’t notice or think about it as much. Once again stripping some of the emotions out and starting out with good habits from the get go.
A bit much here but I hope it’s clear. Good luck and enjoy the blog.
Patrick | Jan 13, 2008 | Reply
My company just announced they will offer a Roth 401(k) plan, which has me stoked! I plan on signing up right away (so long as their offerings are good). I’ve still got 30 years to take advantage of the tax free growth, and going to a Roth vs. Traditional won’t affect my tax bracket I don’t think - so it’s win-win for me.
Great info here.
CHM | Jan 13, 2008 | Reply
Hey Patrick,
That’s excellent news. The Roth 401(k) is a great deal. I’m going to write about the benefits soon.
Also, on Tuesday I’m going to write a piece arguing the Roth is the way to go (v the Traditional IRA) regardless of your future tax bracket.
Thanks for the nice words. Hopefully future posts will be more like yours, practical and interesting, to a broader audience. I’m going to work on that:)
akb | Jan 14, 2008 | Reply
If you can its better to contribute the whole yearly amount at the beginning of the year, rather than monthly. That way all of the interest that money would earn is tax free. If you put the money in a money market you can then dollar cost average your investments from the money market the same as you would have with your monthly contributions.
Amanda @ Me vs Debt | Jan 15, 2008 | Reply
I’m not totally clear on why one should wait until 2010 for a Roth conversion… Otherwise great post. Investing in a Roth IRA is one of my next financial goals.
CHM | Jan 15, 2008 | Reply
Hi Amanda,
Because the laws are changing in 2010. Many people are not eligible to convert into a Roth until the 100,000 income restriction is lifted, which happens in 2010.
2010 is a good year to convert because the gov. is adding an extra incentive… letting you spread out the conversion taxes over 2 years.
Click on the category- 2010 Roth IRA Conversion Event to learn more.
Mrs. Micah | Jan 15, 2008 | Reply
Good to know about the conversion. I’m a fan of all things Roth, and I’ve been trying to figure out how we might someday roll a 403(b) (which we don’t yet have because he’s not eligible yet) into an IRA into a Roth. But that’ll be in a while anyway. Perhaps it’ll get even easier.
And thanks for answering rickshaw’s question, too. I already knew that, but it’s nice to see continued confirmation.
CHM | Jan 16, 2008 | Reply
Mrs. Micah you’re more than welcome. I think it’s pretty obvious how I feel about the Roth IRA:)
I plan to dedicate a few posts to Roth 401(k)’s and will touch on 403(b)’s, as well. Keep an eye out for that.
Jon | Jan 16, 2008 | Reply
I’m curious, do you know why the IRA contribution limit is $5000, but the 401(k) limit is $15,500? It seems like the deck is stacked against people who don’t have employer-sponsored plans. I max out my Roth every year, but would put away more if I were legally allowed.
CHM | Jan 16, 2008 | Reply
Hey Jon,
In your case I’d look to work for an employer that offers a 401k plan, that’s a part of what makes an employer appealing to an employee. If they offer a matching contribution, even better.
If you’re self employed you can setup a solo Roth 401(k) and have the same privileges as the corporate plans.
The laws have been in place like this for along time. Right off the top of my head I’d suggest they were designed this way to make it more appealing for people to work for a company, people need incentives to work for a company, a good retirement plan is one of them.
Jack Payne | Jan 17, 2008 | Reply
What’s this about enhanced IRS scruitiny of Roth IRAs.
I don’t get it. Why?
Jenny | Mar 7, 2008 | Reply
I would like to request permission to reprint this in an upcoming philanthropic newsletter. It is definitely the most donor-friendly, concise version of these updated changes that I have found so far.
CHM | Mar 7, 2008 | Reply
Hi Jenny,
Sure thing… if you would just include a link to my blog, I’d appreciate it. You can also let readers know they can drop by anytime and I’ll answer any questions they might have.
Please send me a copy once it’s published. Thanks
CHM | Mar 7, 2008 | Reply
Hey Jack,
Didn’t see your question, strange, didn’t get an email, usually do when a new comment is posted.
Send me the article you’re talking about. I’ll have a look.
Peter | Mar 9, 2008 | Reply
I contributed $4000 into my Roth IRA account in 2006, without realizing that I was over the AGI limitation. In 2007 I was over the limit again. In your opinion, should I withdraw the excess contribution or I can hold until the year I am eligible to contribute and recharacterize the excess contribution? Thanks.
CHM | Mar 9, 2008 | Reply
Hey Peter,
I’d say that’s entirely up to you. If you’ve been ineligible for 2006 and 2007 I would assume you will once again be ineligible in 2008. Each year is costing you a 6% excise tax. I think you should really look at your expected
compensation for 2008 and use that as the basis for your decision.
After re-characterizing you can always do a Roth conversion in 2010… http://chancefavors.com/2007/07/jumpstart-your-roth-conversion/
steve | Apr 5, 2008 | Reply
I did not know that you had to make less than 100,000 AGI at the year of conv, I converted to a roth in 2006 and made more than that what do i do now yikes
CHM | Apr 5, 2008 | Reply
@Steve - the first thing I would do is speak to a good accountant and let him know what has happened. I’m sure he (or she) will help you to resolve the problem.
Katherine | Jun 8, 2008 | Reply
Widowed in 2006, I am currently living off of life insurance monies therefore have a pretty small income. I’m thinking of converting my entire Traditional to Roth, but I’m concerned about how the money from the conversion will be viewed.
Does the converted money adjust your AGI? Meaning, if I convert more than $100,000 does that make me ineligible for conversion, technically? I’m not earning a lot of interest, I’ve earned about $5000 this year so far. Do I have to subtract $5K from $100,000 for the conversion in order to stay under the AGI limit? Or can I convert my entire traditional to Roth without concern for any limits?