Save time with our cheat sheets, fact sheets, checklists & books!

February 26, 2009

Roth IRAs- The Way to Tax- Free Savings


by Denise Appleby, CISP, CRC, CRPS, CRSP, APA

The Roth IRA is often referred to as the back-ended IRA. This is because unlike Traditional IRAs where benefits can be received upfront by eligible taxpayers who take a tax deduction for contributions, Roth IRA contributions are not deductible. For Roth IRAs, while earnings accrue on a tax-deferred basis, distributions from a Roth IRA that meet certain requirements are tax-free- hence the reference to it having the back-end benefit. The following focuses on the key features of a Roth IRA.


Before deciding to make a contribution to a Roth IRA, individuals must ensure that they are eligible to do so. The eligibility requirements are as follows:

  • The individual’s Modified adjusted gross income (MAGI) must be as follows: less than $105,000 for individuals who file as single, less than $167000  for those who file as married-filing jointly and less than $10,000 for those whose tax filing status is married-filing separately.
  • The individual must have taxable compensation. For this purpose, taxable compensation includes wages, salaries, tips, professional fees, bonuses, and other amounts you receive for providing personal services are compensation.

Unlike Traditional IRAs, there is no age limit on making contributions to Roth IRAs.


One of the primary ways of funding a Roth IRA is to make contributions( to the account). Amounts contributed must be within the statutory limits, which are as follows:


Regular Contribution


Catch-up Contribution

2002 to 2004


2002 to 2005


2005 to 2007


2006 to 2010


2008 to 2010



Note: Catch-up contributions can be made by individuals who reach age 50 by the end of the year for which the contribution is being made.

If an individual’s taxable compensation for the year is less than the limits above, then the contribution is limited to the taxable compensation amount. For instance, if the individual receives $3,000 in taxable compensation for the year, then the most that can be contributed to the individual/s IRA for the year is $3,000.

Excess Contributions

Contributions in excess of the statutory limits are treated as ‘excess contributions’, and must be removed from the IRA by October 15 of the following year in order to avoid penalties. Excess contributions are amounts in excess of the limits indicated in the chart above, or if the taxable compensation is less than these amounts, then an excess contribution would be contributions in excess of the compensation (for the year). If the excess amount is not removed on a timely basis, the individual will owe the IRS an excise tax of 6% of the excess amount for every year it remains in the IRA.

Excess contributions that are removed timely must be accompanied by any applicable earnings or reduced by any applicable losses. A special formula must be used to calculate the earnings/losses on excess contributions. If the IRA custodian does not calculate these earnings/losses, the IRA owner can refer to the instructions provided by the IRS.

Reminder: IRA contributions must be made in cash.

Determining Contribution Limit

If an individual’s MAGI is below certain amounts, contributions may be up to the amounts indicated in the chart above. However, if the MAGI exceeds the amounts indicated earlier under ‘Eligibility’, the individual is not eligible to make a contribution to a Roth .The following table summarizes the MAGI limits that apply to Roth IRA contributions.

Tax Filing Status

2009 MAGI

2010 MAGI

Allowed contribution 


$105,000 or less

$105,000 or less


$105,000  – $120,000

$105,000 – $120,000


$120,000  or more



Married filing jointly

$166,000 or less

$167,000 or less


$166,000 -$176,000

$167,000 – $177,000


$176,000 or more

$177,000 or more


Married filing separately

Less than $10,000

Less than $10,000


$10,000 or more

$10,000 or more


If the MAGI falls within the range for partial contributions, a calculation must be done to determine how much of the contribution the individual is eligible to make.

IRA Contributions Add-up

Contributions to a Roth IRA can add up to significant savings overtime, and can therefore create a good financial resource during retirement years. For instance, assume contributions of  $4,000 each year for a period of twenty years, and the savings accrue interest an annual yield of 5%. The accumulated savings would be as follows:

Opening Balance: 


Number of Deposits


Annual Deposit Amount


Annual Yield

5.00 %

Approximate Ending Balance 


Of course, this means that larger contribution amounts over longer periods, would result in even greater savings amounts.

Conversion Contributions
Roth IRAs can also be funded with assets from a Traditional IRA, SEP IRA or SIMPLE IRA as a Roth conversion. (Note: For SIMPLE IRAs, the assets are eligible to be converted to a Roth only if it has been at least two years since the first contribution was deposited to the SIMPLE IRA ). In order to be eligible for a Roth Conversion, the individual’s tax filing status cannot be married-filing-separately, and the MAGI cannot be more than $100,000. This $100,000 limit applies to both single individuals and married couples who file a joint tax return. Note: These limitations are repealed effective Janaury 1, 2010.

Earnings Tax Deferred- Tax-Free if Qualified

One of the most attractive features of the Roth IRA is that the earnings in the account accrue on a tax-deferred basis. This means that unlike regular savings account where one may need to include the earnings in income for the year earned, earnings in a Roth IRA are not included in income until they are distributed ( withdrawn) from the Roth IRA. Best of all, if distributions are qualified they are tax-free.


Amounts distributed from a Roth IRA are treated as ordinary income. Distributions that occur before age 59 ½ may be subject to an early distribution excise tax (penalty) of 10%, unless the individual qualifies for an exception to this penalty. The list of exceptions includes the following: 

  • The distribution are from amounts converted to the Roth IRA, and it has been at least five years since the amount was converted
  • The distributions are not more than the individual’s unreimbursed medical expenses that exceed 7.5% of your adjusted gross income (AGI).
  • The distributions do not exceed the cost of the individual’s medical insurance.
  • The distributions occur while the individual was disabled. ( disability for this purpose is defined under the Internal Revenue Code (IRC) )
  • The distributions occur from a Roth IRA that was inherited from someone other than the individual’s spouse, of if the person was the individual’s spouse, the individual elected not to treat the Roth IRA as his or her ‘own’
  • The distributions are part of a substantially equal periodic payment (SEPP)/72(t)
  • The distribution amounts do not exceed the individual’s qualified higher education expenses.
  • The distribution amounts were used buy, build, or rebuild a first home (lifetime limit to $10,000).
  • The distribution is as a result on an IRS levy of the Roth IRA.

Determining Taxable Amounts

In order to determine whether a distribution from a Roth IRA is taxable, one must first determine if the distribution is a qualified distribution. Distributions from a Roth IRA are qualified if the following two requirements are met:

  1.  It has been at least five years since the individual made the first contribution or conversion to a Roth IRA, and
  2. The individual qualify for one of the following exceptions to the 10% excise tax:  
  • He/she is at least age 59 ½ when the distribution occurs,
  • The distribution amounts is used buy, build, or rebuild a first home (lifetime limit of $10,000),
  • The distributions occur while the individual is disabled. ( disability for this purpose is defined under the Internal Revenue Code (IRC) /Tax Code), or
  • The distributions are taken from an inherited Roth IRA

Note: Qualified distributions are tax-free and penalty free!

See the article  Roth IRA Distributions-Determining Tax and Penalty for details

Ordering Rules for NonQualified Distributions

If the distribution is not qualified, then the ordering rules must be used to determine the amount that is subject to income tax and/or the 10% penalty. Under these ordering rules, distributions from a Roth IRA are determined to come from three sources (contributions, conversions and earnings) in the following order:

  • Regular contributions
  • Conversion amounts
  • Earnings

Nonqualified distributions are taxed as follows


Tax treatment


Regular contributions

Tax free and penalty free

Contributions can be distributed at anytime without incurring a penalty


  • Tax-free.
  • Penalty free only if it has been at least five years since the amount was converted, or if you qualify for one of the exceptions listed above under “ Distributions”

Conversions are distributed on a first in first out basis. Therefore, if there were multiple conversions over different years, the earlier conversions are considered distributed first.
Conversions are considered to be part of the distribution only if all the regular contributions have already been distributed


  • Taxable.
  • Penalty free only if you qualify for one of the exceptions listed above under “Distributions”.

Earnings are considered to be part of the distribution only if all the regular contributions and conversion amounts have already been distributed


While this is a high level discussion of the features and benefits of a Roth IRA, we hope it helps to shed some light on the benefits of making Roth IRA contributions. Amounts in Roth IRAs can help to ensure a financially secured retirement, and is a great estate planning tool for individuals who want to leave tax-free assets to their heirs. Before deciding to contribute to a Roth IRA, individuals should talk to their financial planners or retirement counselors, so as to determine if another type of savings account, such as the Traditional IRA, is more suitable.



Keep Learning

Be among the first to know when

IRA Rules