Subject: Retirement Plans - Roth IRA

Last-Revised: 17 Feb 2019
Contributed-By: Chris Lott (contact me), Paul Maffia (paulmaf at, Rich Carreiro (rlcarr at

This article gives a broad overview of Roth IRA rules and regulations, and summarizes the differences between a Roth IRA and an ordinary (traditional) IRA. Also see the articles elsewhere in the FAQ for information about the Traditional IRA.

The Taxpayer Relief Act of 1997 established a new type of individual retirement arrangement (IRA). It is commonly known as the "Roth IRA" because it was championed in Congress by Senator William Roth of Delaware. The Roth IRA has been available to investors since 2 Jan 1998; provisions were amended by the IRS Restructuring and Reform Act of 1998, signed into law by the president on 22 July 1998. Provisions were amended by the Economic Recovery and Tax Relief Reconciliation Act of 2001, and again by the Tax Increase Prevention and Reconciliation Act of 2006.

A Roth individual retirement arrangement (Roth IRA) allows tax payers, subject to certain income limits, to save money for use in retirement while allowing the savings to grow tax-free. All of the tax benefits associated with a Roth IRA happen when withdrawals are made: withdrawals, subject to certain rules, are not taxed at all.

(This is in sharp contrast to a ordinary IRA.) Stated differently, Roth IRAs convert investment income (dividends, interest, capital gains) into tax-free income. There are no tax benefits associated with contributions (no deductions on your federal tax return) because all contributions to a Roth IRA are made with after-tax monies.

Funds in an IRA may be invested in a broad variety of vehicles (e.g., stocks, bonds, etc.) but there are limitations on investments (e.g., options trading is restricted, and buying property for your own use is not permitted).

Contributions are limited to $6,000 annually for tax year 2019, and may be restricted based on an individual's income and filing status. An individual may contribute the lesser of US$6,000 or the amount of compensation income from US sources to his or her IRA account(s). Individuals who are age 50 or older may contribute an additional $1,000, for a total of $7,000. Compensation income includes wage income and self-employment income; it excludes investment and pension income, just to name two examples. A notable exception to the compensation rule was introduced in 1997, namely that married couples with only one wage earner may each contribute the full amount to their respective Roth IRA accounts. This is the "spousal IRA" rule, which states that married people who file their taxes jointly can count each other's income when figuring contribution eligibility. These contribution limits are quite low in comparison to arrangements that permit employee contributions such as 401(k) plans (see the article on 401(k) plans in this FAQ for extensive information about those accounts).

There are absolutely no limits on the number of IRA accounts that an individual may have, but the contribution limit applies to all accounts collectively. In other words, an individual may have 34 ordinary IRA accounts and 16 Roth IRA accounts, but can only contribute $6,000 total to those accounts (the appropriate limit for the tax year), divided up any way he or she pleases. You can write a lot of little checks if you have many accounts, but that would be silly.

Taxpayers are permitted to contribute monies to a Roth IRA only if their income lies below certain thresholds. Participation in any other retirement plan has no influence on whether a person may contribute to a Roth IRA or not. More specifically, a person's Modified Adjusted Gross Income (MAGI) must pass an income test for contributions to the Roth IRA to be permitted. The 2019 income tests for individuals filing singly, couples with filing status Married Filing Jointly (MFJ), and couples living together with filing status Married Filing Separately (MFS) look like this:

  • MAGI less than 122k (MFJ 193k, MFS 0k): full contribution allowed
  • MAGI in the range 122-137k (MFJ 193-203k), MFS 0-10k: partial contribution allowed
  • MAGI greater than 137k (MFJ 203k, MFS 10k): no contribution allowed.
That's right, the limits on married couples who file separate tax returns are pretty darned low. These limits increased modestly in 2019 for single and MFJ filers, but did not change for MFS filers.

A bit of trivia: the Roth contribution phaseout, like the phaseout for the deductibility of ordinary IRA contributions, has a kink in it. As long as the MAGI is within the phaseout range, the allowable contribution will not be less than $200, even though a strict application of the phaseout formula would lead to an amount less than $200. So as your MAGI works its way into the phaseout, your contribution will drop linearly from $2000 down to $200, then will stay at $200 until you hit the end of the phaseout, where it then drops to $0.

Annual IRA contributions can be made between January 1 of that year and April 15 of the following year. Because of the extra three and a half months, if you send in a contribution to your IRA custodian between January and April, be sure to indicate the year of the contribution so the appropriate information gets sent to the IRS. Remember, contributions to a Roth IRA are never deductible from a taxpayer's income (unlike an ordinary IRA).

The rules for penalty-free, tax-free distributions from a Roth IRA account are fairly complex. First, some terminology: a Roth account is built from contributions (made annually in cash) and conversions (from an ordinary IRA). Earnings are any amounts in the account beyond what was contributed or converted. The rules are as follows:

  • Contributions can be withdrawn tax-free and penalty-free at any time.
  • There is 5-year clock 'A'. Clock 'A' starts on the first day of the first tax year in which any Roth IRA is opened and funded.
  • Earnings can be withdrawn tax-free and penalty-free after Clock 'A' hits 5 years and a qualifying event (such as turning 59.5, disability, etc.) occurs.
  • Additional 5-year clocks 'B', 'C', etc. start running for each ordinary IRA that is converted to a Roth IRA. Each clock applies just to that conversion.
  • If you are under age 59.5 when a particular conversion is done, and you withdraw any conversion monies before the clock associated with that particular conversion hits 5 years, you are hit with a 10% penalty on the withdrawn conversion monies. If you are over age 59.5 when you did the conversion, no penalty is applied no matter how soon you withdraw the monies from that conversion.
  • The order of withdrawals (distributions) has been established to help investors. When a withdrawal is made, it is deemed to come from contributions first. After all contributions have been withdrawn, subsequent withdrawals are considered to come from conversions. After all conversions have been withdrawn, then withdrawals come from earnings. I believe the conversions are taken in chronological order.
  • All Roth IRA accounts are aggregated for the purpose of applying the ordering rules to a withdrawal.

A huge difference between Roth and ordinary IRA accounts involves the rules for withdrawals past age 70 1/2. There are no requirements that a holder of a Roth IRA ever make withdrawals (unlike an ordinary IRA for which required minimum distribution rules apply). This provision makes it possible to use the Roth IRA as an estate planning tool. You can pass on significant sums to your heirs if you choose; the account must be distributed if the holder dies.

What the Roth IRA allows you to do, in essence, is lock in the tax rate that you are currently paying. If you think rates are going nowhere but up, even in your retirement, the Roth IRA is a sensible choice. But if you think your tax rate after retirement will be less, perhaps much less, than your current tax rate, it might be wiser to stick with a conventional IRA. (To be picky, you really need to think about the tax rate when you are eligible to take tax-free, penalty-free distributions, which is age 59 1/2.)

Should you use a Roth IRA at all? Answering this question is tricky because it depends on your circumstances. In general, experts agree that if you have a 401(k) plan available to you through your employer, you should max out that account before looking elsewhere. Otherwise, if you are allowed to put money in a Roth IRA at all (i.e., if your income is below the limits), then making contributions to a Roth IRA is always preferable over making contributions to a nondeductible IRA. You pay the same amount of taxes now in both cases, because neither is deductible, but you don't pay taxes on withdrawal from the Roth (unlike withdrawals from an ordinary IRA). The only exception here is if you're going to need to pull the money out before the minimum holding period of 5 years.

Holders of ordinary IRA accounts are permitted to convert their accounts to Roth IRA accounts. Prior to 2010 the law limited conversions with an income test. Unlike those previous tax years, in 2010 and subsequent years there is no income-based limit, nor any limit based on a taxpayer's filing status. The conversion is a taxable event. Contributions are still subject to income-based limits as discussed elsewhere in this article.

Tax is owed on the amount converted, less any nondeductible contributions that were made over the years. But note that over the years Congress has legislated special deals on conversions. Income resulting from a conversion in 1998 could optionally be divided by 4 and indicated as income in equal parts on 1998--2001 tax returns. Income resulting from a conversion in 2010 could optionally be divided by 3 and indicated as income in equal parts on 2010-2012 tax returns. Income form a conversion made in other years is fully taxed in the year of the conversion. Deductible contributions and all earnings are taxed; non-deductible contributions are considered return of capital and are not taxed.

If you convert only a portion of your IRA holdings to a Roth IRA, the IRS says that these withdrawals are considered to be taken ratably from each ordinary IRA account. You compute the rate by finding the ratio of deductible to non-deductible contributions (also known as computing your IRA basis). This ignores growth or shrinkage of the account's value. For example, if you stashed $9,000 in deductible contributions and $3,000 in non-deductible contributions for a total of $12,000 in contributions to your ordinary IRA, your basis would be 25% of the total contributions. When you make a withdrawal, 25% will considered to be from the non-deductible portion and 75% from the deductible portion (and hence taxable). Not certain whether the proper way to say this is that your basis is 25% or 75%, but you get the idea.

The technical corrections bill of 1998 added a provision that investors could unconvert (and possibly recovert) with no penalty to cover the case of a person who converted, but then became ineligible due to unexpected income. This opened a loophole: it put no limit on the number of switches back and forth. With the decline in the markets of 1998, many people unconverted and reconverted to establish a lower cost basis in their Roth IRA accounts. The IRS issued new regulations in late October, 1998 that disallow this strategy effective 1 Nov 98, but grandfather any reconversions that predate the new regulations. Under the new regulations, IRA holders are allowed just one reconversion.

If you are eligible to convert your ordinary IRA to a Roth IRA, should you? Again answering this question is non-trivial because each investor's circumstances are very different. There are some generalizations that are fairly safe. Young investors, who have many years for their investments to grow, could benefit handsomely by being able to withdraw all earnings free of tax. Older people who don't want to be forced to withdraw funds from their accounts at age 70 1/2 might find the Roth IRA helpful (this is the estate planning angle). On the other hand, for people who have significant IRA balances, the extra income could push them into a higher tax bracket for several years, cause them to lose tax breaks for some itemized deductions, or increase taxes on Social Security benefits.

The following illustrated example may help shed light on the benefits of a Roth IRA and help you decide whether conversion is the right choice for you. The numbers in this example were computed by Vanguard for their pages (see the link below). In many situations the differences between the two types of accounts is quite small, which is perhaps at odds with the hype you might have seen recently about Roth IRAs. But let's let the number speak for themselves.

We're going to compare an ordinary deductible IRA with a Roth IRA. Each begins with $2,000, and we'll let the accounts grow for 20 years with no further contributions. We'll assume a constant rate of return of 8%, compounded annually, just to keep things simple. We'll also assume the contribution to the ordinary IRA was deductible because otherwise the Roth is a clear winner. Here's the situation at the start; we assume the 28% tax bracket so you have to start by earning 2,778 just to keep 2,000.

What Ordinary IRA Roth IRA
Gross wages 2,778 2,778
Contributions 2,000 2,000
Taxable income 778 2,778
28% federal tax 218 778
What's left 560 0
So at this point, the ordinary IRA left some money in your pocket, but the Feds and the Roth IRA took it all. But we're not going to spend that money, no sir, we're going to invest it at 8% too, although it's taxed, so it's really like investing it at 72% of 8%, or about 6%. After 20 years we withdraw the full amount in each account. What's the situation?
What Ordinary IRA Roth IRA
Account balance 9,332 9,332
28% federal tax 2,613 0
What's left 6,719 9,332
Outside investment 1,716 0
Net result 8,435 9,332
So this worked out pretty well for the Roth IRA. A key assumption was that the use of the same tax rate at withdrawal time. If the tax rate had been significantly less, then the Ordinary IRA would have come out ahead. And of course you had the discipline to invest the money that the ordinary IRA left in your hands instead of blowing it in Atlantic City.

I hope that this example illustrated how you might run the numbers for yourself. Before you do anything, I recommend you seriously consider getting advice from a tax professional who can evaluate your circumstances and make a recommendation that is most appropriate for you.

If you've decided to convert your ordinary IRA to a Roth IRA, here are some tips offered by Ellen Schultz of the Wall Street Journal (paraphrased from her article of 9 Jan 1998).

Pay taxes out of your pocket, not out of your IRA account.
If you use IRA funds to pay the taxes incurred on the conversion (considered a withdrawal from your ordinary IRA), you've lost much of the potential tax savings. Worse, those funds will be considered a premature distribution and you may be hit with a 10% penalty!
Consider converting only part of your IRA funds.
This decision is up to you. There is no requirement to convert all of your accounts.
Conversion amounts don't affect your conversion eligibility.
When you convert, the withdrawal amount does not count towards the 100k limit on income.

As a final note, you should be careful about any fees that the trustee of your Roth IRA account might try to impose. For comparison, Waterhouse offers a no-fee Roth IRA.

Just for the record, a number of changes were made in 1998 to the original Roth provisions ("technical corrections"). One problem that was corrected was that the original law included a tax break for conversion Roth accounts. Specifically, there was no penalty on early withdrawals from conversion accounts. This means that any money converted (and any earnings after conversion) to a Roth from an ordinary IRA could be withdrawn at any time without penalty, so you could roll to a Roth IRA and use your ordinary IRA money immediately without penalty. The technical corrections bill corrected this by requiring that 5 years elapse after conversion before any sums can be withdrawn. Also, under the wording of the original law, the minimum 5-year holding period for a Roth conversion account was based on the date of the last deposit into that account. One of the consequences of the second problem was that the IRS was insisting on keeping the conversion accounts separate from contribution (new money) accounts so as to minimize the potential damage (tax collection-wise) if the correction was not made (but of course it was). Another change lowered the already low income test for couples filing MFS from 15k to 10k.

The rules changed in mid 2001 in the following ways:

  • The contribution limit was indexed for inflation starting in 2011, although the limit did not change for 2012.
  • The catch-up provision that allows investors over 50 to contribute extra money are as follows: tax years 2002-2005, $500; tax years 2006--2019, $1000. This limit too was indexed for inflation starting in 2011, but did not change for 2014.

The conversion rules changed on 1 Jan 2010. Through the end of 2009, conversions were only permitted for a tax payer who passed both an income limit and a tax filing status check. All ordinary IRA holders may convert to a Roth IRA in 2010, as discussed above.

Here's a list of sources for additional information, including on-line calculators that will help you decide whether you should convert an ordinary IRA to a Roth IRA.

For the very last word on the rules and regulations of Roth IRA accounts, get IRS Publication 553.

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