The Basics of Roth IRAs

I’ve received quite a few questions recently about how Roth IRAs work, so I figured it would be helpful to put several questions and answers together as an all-in-one Roth IRA guide.

Contribution limits

Everything I read about preparing for retirement says to “save like mad.” What are the rules and contribution limits for Roth IRAs?

You’re smart to start saving early for retirement in an IRA. The more you can take advantage of tax-advantaged retirement accounts, the easier it is to stretch your savings. You can contribute up to $5,000 to an IRA for 2011 (or $6,000 if you’re age 50 or older by the end of the year), and you still have until April 18, 2011, to make your 2010 contribution. You can contribute to either a traditional IRA or a Roth, if you are eligible, or a combination of the two types of accounts, as long as your total IRA contributions for the year don’t exceed the $5,000 maximum (or $6,000 if you’re 50 or older).

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You are eligible to contribute to a Roth IRA if your modified adjusted gross income is $122,000 or less if you’re single, or $177,000 or less if you’re married filing jointly. You don’t get a current tax deduction with a Roth as you do with a traditional IRA (in most cases), but you can access your Roth contributions penalty-free and tax-free at any time, and you can withdraw the earnings tax-free after age 59½. A Roth has a few additional advantages, too -- you won’t have to take required minimum distributions beginning at age 70½, as you would with a traditional IRA, and your heirs can inherit any money remaining in your Roth IRA income-tax-free after you die.

See Get the Most Out of Your Retirement Accounts for more information about the 2011 income limits and rules for Roth IRAs and tax-deductible traditional IRAs.

Can you invest in both a 401(k) and a Roth?

Yes, you can contribute to both a Roth IRA and an employer-provided 401(k) in the same year. For 2011, you can contribute up to $16,500 to a 401(k) (or up to $22,000 if you’re 50 or older by the end of the year).

Roth conversions

I earn too much to contribute to a Roth IRA, but I would like to contribute to a traditional IRA and then convert it to a Roth (see Back Door to an IRA). If I make my 2010 IRA contribution before April 18, 2011, can I still take advantage of the special tax rule that allows me to spread the converted amount -- and resulting tax bill -- over two years?

No. That was a special deal for conversions made in the 2010 only. If you had converted your traditional IRA to a Roth in 2010, you could have chosen to pay the taxes on the conversion all at once when you file your 2010 return or to pay half the tax bill on your 2011 return and the balance on your 2012 return. Although you still have until April 18, 2011, to make your 2010 IRA contribution, it’s too late to take advantage of the one-time opportunity to spread your tax bill over two years.

However, the back door into an IRA is still open: If you earn too much to qualify for a Roth IRA, you can contribute to a traditional IRA and then convert the IRA to a Roth, regardless of your income. It will count as a 2011 conversion, and you’ll have to pay the tax on that conversion when you file your 2011 taxes next spring.

Roths and the self-employed

I’m self-employed and file Schedule C. Can I still contribute to a Roth IRA?

You can contribute to a Roth IRA if your modified adjusted gross income is below the $122,000 cut-off for single filers, or $177,000 if married filing jointly -- whether you work for an employer or work for yourself. But because you’re self-employed, you have an even better option for saving for retirement: You can open a solo 401(k), which allows you to contribute up to $49,000 (depending on your income), plus an additional $5,500 if you are 50 or older, for a total of $54,500 for 2011. You can choose either a traditional solo 401(k), which enables you to deduct your retirement contributions from your income taxes now, or a Roth solo 401(k), which will provide tax-free withdrawals in retirement. See Retirement Accounts for the Self-Employed for details.

No age restrictions

Is there a minimum or a maximum age to contribute to a Roth IRA?

No. Unlike traditional IRAs, which permit contributions only until age 70½, Roth IRAs have no age limit for contributing, as long as you have earned income from a job and you meet the income-eligibility limits. See Roth IRAs for Kids for more information about the rules for opening a Roth IRA for your child and about the fund companies and brokerage firms that offer good deals. And if you aren’t working now for any reason (because you’ve retired, say, or you’re a stay-at-home parent) but your spouse still has a job, then he or she can contribute up to $5,000 (or $6,000 if you’re 50 or older) per year on your behalf. See Roth IRA Contribution Rules for more information.