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Roth: Too good to be true
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August 30, 2000: 12:18 p.m. ET
Understand the rules for an IRA that allows you to withdraw the money tax-free
By Ed Slott
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NEW YORK (CNNfn) - Yes, the Roth IRA is too good to be true. But many people are still not participating, possibly due to a lack of understanding of the basic provisions.
If this sounds like you, here are the Roth IRA basics. Hopefully you'll see the light and start taking advantage of this incredible tax-free retirement savings account.
Roths come in two flavors, the $2,000 contribution or the Roth conversion. The big money is in the Roth conversion. The only roadblock is that in order to qualify for a Roth IRA conversion, your income cannot exceed $100,000.
 For some strange reason that $100,000 limit is the same whether you are single or married. So don't marry anyone before you convert! Your new bride or groom may kill your only chance for the Roth conversion. Once you marry, if your new spouse works, chances are that your joint income may exceed the $100,000. Don't even think about getting around this by filing "married-separate." If you file "married-separate" you cannot convert at all, regardless of income.
When you convert to a Roth IRA from a traditional IRA, you will pay tax on the amount converted.
If you have other, non-IRA money to pay the tax with, you should convert all you can. If you do not pay the conversion tax now, you'll eventually pay more income tax later, because all the growth in your regular IRA will eventually be taxed anyway and withdrawals from that account must begin after your Required Beginning Date (RBD). The RBD is April 1 of the year after you turn 70-1/2. That is not the case with a Roth IRA.
To qualify for the annual $2,000 per person Roth contribution (or $4,000 if married and filing jointly), you must have at least that much in earned income and your income cannot exceed the phase-out range. The term "phase-out" is tax talk for "you no longer qualify."
The phase-out range is $95,000 to $110,000 of income for single people and $150,000 to $160,000 if married and filing jointly. Roth contributions are not tax deductible, but once the account is held for five years and you reach 59 1/2 years old, all withdrawals from the account are income tax free forever, for you and your Roth IRA beneficiaries.
Visit Ed Slott's irahelp.com.
Roth IRA owners are not subject to any of those complicated age 70 1/2 distribution rules because there is no Required Beginning Date or mandatory distributions for Roth IRA owners or their spouses who inherit. You can contribute to a Roth IRA after age 70 1/2 if you like. You cannot do that with a traditional IRA.
In addition, you can contribute to the Roth even if you are active in a 401(k) or other pension plan from your job. If you participate in a company plan, you may not be able to deduct your traditional IRA contribution, due to income limits.
Recharacterization
A recharacterization is when you want to undo your Roth conversion as if it never happened. In a recharacterization, your converted Roth money goes back to a traditional IRA and is treated for the five-year rules as if it were always in your Roth as of the first day of the year of conversion.
Recharacterizations can also occur when money goes from a $2,000 traditional IRA to a Roth IRA, or vice-versa. Again, the money is treated as if it were always in the IRA it was transferred to. For example, you contribute $2,000 to your traditional IRA to gain a tax deduction, but because you are active in a pension plan and your income is too high, you cannot deduct your traditional IRA contribution.
You could leave it as a non-deductible contribution, but the better option would be to recharacterize it as a Roth IRA. After the recharacterization, the money would be treated as if it were never in the traditional IRA and was originally contributed directly to the Roth.
Read Ed Slott's recent columns on the three most important decisions you'll make with your IRA: Choosing a beneficiary; picking a life expectancy and picking a distribution method.
The recharacterization works the other way as well. You can recharacterize a Roth IRA to a traditional IRA. Assume that you contributed to a Roth IRA in 2000, but after you filed your 2000 tax return in April 2001, you realized that your income was too high to be able to contribute to a Roth IRA. You have until October 15, 2001 to recharacterize a 2000 Roth IRA contribution as a traditional IRA.
Reconversion
A reconversion occurs after a recharacterization. For example, you converted from your traditional IRA to a Roth IRA, then recharacterized that Roth IRA back to the traditional IRA, and then reconverted (converted once again) to a Roth IRA. There are no limits on reconversions. If you recharacterize converted funds in 2000, you cannot reconvert those same funds in 2000. You must wait until 2001 or more than 30 days, whichever period is longer, to reconvert.
Therefore, if you convert in September 2000, then recharacterize on December 20, 2000, you must wait until January 20, 2001 before you can reconvert those same funds. If you recharacterized on November 20, 2000, then you could reconvert on January 1, 2001.
A recap: What you can do in 2000
- Conversions: You can convert to a Roth IRA (a year 2000 conversion)
- Recharacterizations: You can recharacterize your 1999 Roth IRA, up to October 15, 2000; or you can recharacterize your 2000 Roth IRA, at anytime during 2000 and up to October 15, 2001
- Reconversions: You can reconvert the 1999 recharacterized funds, but you must wait more than 30 days from the date of the recharacterization
- You cannot reconvert your 2000 conversion in 2000. You must wait until 2001, or 30 days, whichever is longer.
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