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Word of the Week 'Roth IRA'


Named for Delaware Senator William Roth and established by the Taxpayer Relief Act of 1997, a Roth IRA is an individual retirement plan (a type of qualified retirement plan) that bears many similarities to the traditional IRA. The biggest distinction between the two is how they’re taxed.

Traditional IRA contributions are generally made with pretax dollars; you pay income tax when you withdraw the money from the account during retirement. Conversely, Roth IRAs are funded with after-tax dollars; the contributions are not tax deductible (although you may be able to take a tax credit of 10 to 50% of the contribution), depending on your income and life situation). But when you start withdrawing funds, qualified distributions (see below) are tax free.


Similar to other individual retirement plan accounts, the money invested within the Roth IRA grows tax free. Other defining characteristics of a Roth:

  • Contributions can continue to be made once the taxpayer is past the age of 70½, as long as he or she has earned income.

  • The taxpayer can maintain the Roth IRA indefinitely; there is no required minimum distribution (RMD) during the account holder's lifetime.

  • Eligibility for a Roth account depends on income.

Establishing a Roth IRA

A Roth IRA must be established with an institution that has received IRS approval to offer IRAs. These include banks, brokerage companies, federally insured credit unions and savings & loan associations.

A Roth IRA can be established at any time. However, contributions for a tax year must be made by the IRA owner’s tax-filing deadline, which is generally April 15 of the following year. Tax-filing extensions do not apply.

There are two basic documents that must be provided to the IRA owner when an IRA is established:

  • the IRA disclosure statement

  • the IRA adoption agreement and plan document

These provide an explanation of the rules and regulations under which the Roth IRA must operate, and establish an agreement between the IRA owner and the IRA custodians/trustee.

IRAs fall under a different insurance category than conventional deposit accounts. Therefore, coverage for IRA accounts is less. The Federal Deposit Insurance Corporation (FDIC) still offers insurance protection up to $250,000 for traditional or Roth IRA accounts, but account balances are combined rather than viewed individually. For example, if the same banking customer has a certificate of deposit held within a traditional IRA with a value of $200,000 and a Roth IRA held in a savings account with a value of $100,000 at the same institution, the account holder has $50,000 of vulnerable assets without FDIC coverage.

Not all financial institutions are created equal. Some IRA providers have an expansive list of investment options, while others are more restrictive. Almost every institution has a different fee structure for your Roth IRA, which can have a significant impact on your investment returns.

Your risk tolerance and investment preferences are going to play a role in choosing a Roth IRA provider. If you plan on being an active investor and making lots of trades, you want to find a provider that has lower trading costs. Certain providers even charge you an account inactivity fee if you leave your investments alone for too long. Some providers have more diverse stock or exchange-traded fund offerings than others; it all depends on the type of investments you want in your account.

Pay attention to the specific account requirements as well. Some providers have higher minimum account balances than others. If you plan on banking with the same institution, see if your Roth IRA account comes with additional banking products.

Compensation Defined

For individuals working for an employer, compensation that is eligible to fund a Roth IRA includes wages, salaries, commissions, bonuses and other amounts paid to the individual for services the individual performs for an employer. At a high level, eligible compensation is any amount shown in Box 1 of the individual's Form W-2.

For a self-employed individual or a partner in a partnership, compensation is the individual’s net earnings from his or her business, less any deduction allowed for contributions made to retirement plans on the individual’s behalf, and further reduced by 50% of the individual’s self-employment taxes.

Other compensation eligible for the purposes of making a regular contribution to a Roth IRA includes taxable amounts received by the individual because of a divorce decree.

The following sources of income are not eligible compensation for the purposes of making contributions to a Roth IRA:

  • rental income or other profits from property maintenance

  • interest income

  • pension or annuity income

  • stock dividends and capital gains

Contributing to a Roth IRA

In 2017 and 2018 an individual may make an annual contribution of up to $5,500 to a Roth IRA.

Individuals who are age 50 and older by the end of the year for which the contribution applies can make additional catch-up contributions (up to $1,000 in 2017 and 2018). For instance, an individual who is under age 50 may contribute up to $5,500 for tax year 2017, but an individual who reached age 50 by year-end 2017 may contribute up to $6,500.

All regular Roth IRA contributions must be made in cash (which includes checks); regular Roth IRA contributions cannot be made in the form of securities. However, a variety of investment options exist within a Roth IRA, once the funds are contributed, including mutual funds, stocks, bonds, ETFs, CDs and money market funds.

A Roth IRA can be funded from several sources:

  • Regular contributions

  • Spousal IRA contributions

  • Transfers

  • Rollover contributions

  • Conversions

  • Recharacterizations

The Spousal Roth IRA

An individual may establish and fund a Roth IRA on behalf of his/her spouse who makes little or no income. Spousal Roth IRA contributions are subject to the same rules and limits as that of regular Roth IRA contributions. The spousal Roth IRA must be held separately from the Roth IRA of the individual making the contribution, as Roth IRAs cannot be held as joint accounts.

For an individual to be eligible to make a spousal Roth IRA contribution, the following requirements must be met:

  • The couple must be married and file a joint tax return

  • The individual making the spousal Roth IRA contribution must have eligible compensation

  • The total contribution for both spouses must not exceed the taxable compensation reported on their joint tax return

  • Contributions to one Roth IRA cannot exceed the contribution limits for one IRA (however, together the two accounts allow the family to double its savings)

Eligibility Requirements

Anyone who has taxable income can contribute to a Roth IRA – as long as he or she meets certain requirements concerning filing status and modified adjusted gross income (MAGI). Those whose annual income is above a certain amount, which the IRS adjusts periodically, become ineligible to contribute.

For 2017 (and 2018), the income maximums are:

  • $196,000 for individuals who are married and file a joint tax return ($199,000 for 2018)

  • $10,000 for individuals who are married, lived with their spouses at any time during the year and file a separate tax return (same for 2018)

  • $133,000 for individuals who file as single, head of household, or married filing separately and did not live with their spouses at any time during the year ($135,000 for 2018)

The IRS sets income limits that reduce or “phase out” the amount of money one is allowed to contribute. Here is a chart outlining the ranges for each tax-filing category in 2017:non

CategoryIncome Range for 2017 (2018)

Married and filing a joint tax returnAt least $186,000 but less than $196,000 ($189,000, $199,000 for 2018)

Married, filing a separate tax return and lived with spouse at any time during the yearMore than zero but less than $10,000

Single, head of household or married filing separately without living with spouse at any time during the yearAt least $118,000 but less than $133,000 ($120,000, $135,000 for 2018)

These individuals must use a formula to determine the maximum amount they may contribute to a Roth IRA. An individual who earns less than the ranges shown for his or her appropriate category can contribute up to 100% of his or her compensation or the contribution limit, whichever is less.

Withdrawing Funds From a Roth IRA: Qualified Distribution

At any time, you may withdraw contributions from your Roth IRA both tax- and penalty-free. If you withdraw only the amount of your Roth contributions, the distribution is not considered taxable income and is not subject to penalty, regardless of your age or how long it has been in the account. Roth withdrawals are made on a FIFO basis (first in, first out) – so any withdrawals made come from contributions first. Therefore, no earnings are considered withdrawn until all contributions have been withdrawn.

For a distribution of account earnings to be qualified, it must occur at least five years after the Roth IRA owner established and funded his/her first Roth IRA, and the distribution must occur under at least one of the following conditions:

  • The Roth IRA holder is at least age 59½ when the distribution occurs.

  • The distributed assets are used toward the purchase – or to build or rebuild – a first home for the Roth IRA holder or a qualified family member (the IRA owner's spouse, a child of the IRA owner and/or of the IRA owner's spouse, a grandchild of the IRA owner and/or of his or her spouse, a parent or other ancestor of the IRA owner and/or of his or her spouse). This is limited to $10,000 per lifetime.

  • The distribution occurs after the Roth IRA holder becomes disabled.

  • The assets are distributed to the beneficiary of the Roth IRA holder after the Roth IRA holder's death.

Withdrawing Funds From a Roth IRA: Non-Qualified Distribution

A withdrawal of earnings that does not meet the above requirements is considered a non-qualified distribution and may be subject to income tax and/or a 10% early-distribution penalty. There may be exceptions, however, if the funds are used:

For unreimbursed medical expenses – If the distribution is used to pay unreimbursed medical expenses, the amount that exceeds 7.5% of the individual's adjusted gross income (AGI) for the year of the distribution will not be subjected to the early-distribution penalty in 2017 and 2018, under the new tax bill. In other words, the amount paid for the unreimbursed medical expenses minus 7.5% of the individual's adjusted gross income for the year of the distribution can be distributed penalty free. (In 2019, the figure is likely to return to the current requirement – the amount that exceeds 10% of the individual's adjusted gross income (AGI) for the year of the distribution.)

To pay medical insurance – If the individual has lost his or her job.

For qualified higher-education expenses – If the distribution goes toward qualified higher-education expenses of the Roth IRA owner and/or his or her dependents. These qualified education expenses are tuition, fees, books, supplies and equipment required for the enrollment or attendance of a student at an eligible educational institution, and must be used in the year of the withdrawal.

There is yet another loophole for earnings. If you withdraw only the amount of your contributions made within the current tax year, including any earnings on those contributions, then they are treated as if they were never made. If you contribute $5,000 in the current year and those funds generate $500 in earnings, you can withdraw the full $5,500 tax-free and penalty-free if the distribution is taken before your tax filing due date.

Roth IRA vs. Traditional IRA

Whether or not a Roth IRA is more beneficial than a traditional IRA depends on the tax bracket of the filer, the expected tax rate at retirement and personal preference. Individuals who expect to be in a higher tax bracket once they retire may find the Roth IRA more advantageous since the total tax avoided in retirement will be greater than the income tax paid on the contribution amount in the present. Therefore, younger and lower-income workers may benefit the most from the Roth IRA. Indeed, by beginning to save with an IRA early in life, investors make the most of the snowballing effect of compound interest: Your investment and its earnings are reinvested and generate more earnings, which are reinvested and so on.

High wage earners who expect a lower tax rate in retirement can also benefit from a Roth IRA. Many investors simply prefer to receive a tax-free income stream in retirement. And those who don't need their Roth IRA assets in retirement can leave the money to accrue indefinitely – required minimum distributions (RMDs) after age 70½ don't apply to these accounts – and pass the assets to heirs tax-free upon death. (Even better, while the beneficiary must take distributions from an inherited IRA, he or she can stretch out tax deferral by taking distributions based on how long he or she is expected to live). Also, a spouse can roll over an inherited IRA into a new account and not have to begin taking distributions until age 70½.

Some open or convert to Roth IRAs because they fear an increase in taxes in the future, and this account allows them to lock in the current tax rates on the balance of their conversions. Executives and other highly compensated employees who are able to contribute to a Roth retirement plan through their employers can also roll these plans into Roth IRAs with no tax consequence and then escape having to take mandatory minimum distributions when they turn 70½.

As of the end of 2016, investors held $660 billion in Roth IRA accounts, slightly more than 8% of total IRA assets of $7.9 trillion.

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