Learning Center

IRA's (P2)

How much can one contribute to a Roth IRA?
Today individuals can contribute up to $5,000 (see IRS.gov for additional information). Generally, any retirement plan that can be rolled over to an IRA can be converted to a Roth IRA. This includes 401(k)s, 403(b)s, SEPs, etc. While income taxes must be paid on the amount converted, the opportunity for tax-free growth and tax-free distributions could make this a wise choice. (Be sure to consult with a tax advisor to determine the tax consequences of a Roth IRA conversion for individual circumstances.)

How does “tax deductible” compare to “tax free”?
To answer that question, consider a simple example of two individuals, Paul and Julia, who are both age 70 and who both have a $150,000 balance in their IRA. Paul has a traditional IRA and as such, he deducted all of his contributions over the years. Certainly these tax deductions have provided him with a valuable tax advantage each time he made a contribution, but when Paul takes the money out of his IRA, his entire $150,000 nest egg is taxable. This means that if he is in a 33% tax bracket, $50,000 of his IRA will be used to pay taxes, and only $100,000 will remain for his own use.

Julia, however, converted her traditional IRA to a Roth IRA years earlier. Again, her current balance is also $150,000. She has met all of the requirements to withdraw her Roth IRA nest egg completely tax free. This means that the dollar value of Julia’s Roth IRA is identical to the dollar value of Paul’s traditional IRA, but when she withdraws her funds, the after-tax value is 50% greater! The value of Julia’s Roth IRA is 50% greater because she can withdraw the entire $150,000 without paying any income taxes. A full 100% of the distributions is available to support Julia’s retirement lifestyle.

Of course, it is only fair to consider the taxes Julia would have been required to pay when she converted her traditional IRA into a Roth IRA. Assume she was age 55 when she made the conversion. At that time she had $75,000 in her traditional IRA. If she were in a 33% tax bracket at the time, she would have been required to pay $25,000 in taxes.

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