The Motley Fool Discussion Boards

Previous Page

Financial Planning / Tax Strategies


Subject:  Re: definition of self-employed? Date:  12/19/1997  8:14 PM
Author:  TMFTaxes Number:  953 of 123001

<<It looks like the Roth IRA would be the best bet, as my SEP income totals only ~$8K. The only
reason I was interested in the SEP was the possibility of making a contribution larger than $2K.

Am I correct in assuming that any gain on investments in a Roth IRA will never be taxed?>>

First of all, remember that the Roth IRA is only available beginning in 1998. So for 1997, your option is limited to a regular IRA.

As far as the Roth IRA goes, in order for the income to be received tax free, there are various standards that must be met. Check this out for some additional details...

The NEW Roth IRA

Effective for tax years beginning after 1997, there's a new type of back-ended IRA - called the Roth IRA - to which taxpayers and spouses (even those who have attained age 70-1/2 and/or are a participant in another qualified employer pension or profit sharing plan) will be able make annual nondeductible contributions of up to $2,000 of compensation. Qualified distributions (defined below) from a Roth IRA will be tax-free.

Contribution limits: The amount that can be contributed to a Roth IRA for an individual will be reduced by the excess of:

1. the maximum amount allowable as an IRA deduction for the individual for the year (determined without regard to the ban on non-Roth IRA contributions for age-70-1/2 taxpayers and the AGI-based phaseouts for active plan participants), over

2. the total amount of the year's contributions to all non-Roth-IRAs maintained for the taxpayer's benefit.

In effect, what this really means is that you can not contribute to both a Roth IRA and a regular (non-Roth) IRA in the same year. So you may have a decision to make as to the IRA which might be best for you.

In addition: Contributions to Roth IRAs won't be available to higher-income taxpayers. The otherwise allowable Roth IRA contribution will be phased out if your Adjusted Gross Income (AGI) exceeds $150,000 for joint filers and $95,000 for single taxpayers, and will be gone completely when AGI reaches $160,000 (joint filers) or $110,000 (single taxpayers).

Remember: The phase-out ranges for Roth IRAs apply regardless of whether the taxpayer is an active participant in an employer-sponsored retirement plan.

Exclusion for qualified distributions from Roth IRAs: After the 5-year period (explained below), a distribution from a Roth IRA will be tax and penalty-free if it is:

1. made on or after age 59-1/2 or death,

2. made on account of disability, or

3. used for qualifying first time homebuyer expenses

An otherwise eligible distribution won't be qualified if made within the 5-tax-year period beginning with the first tax year for which a contribution was made to the individual's Roth IRA. For payouts properly allocable to rollovers from a non-Roth IRA (see below), the 5-year period begins with the tax year in which the rollover contribution was made.

Nonqualified distributions from Roth IRAs: Roth-IRA payouts that aren't qualified distributions will be taxed and the taxable portion of pre-age-59-1/2 withdrawals will be penalized, subject to the 10%-penalty exceptions applicable to premature distributions from non-Roth IRAs. If a nonqualifying payout is made, contributions to the Roth-IRA will be recovered tax-free before earnings are taxed. In addition, the proposed Technical Corrections bill (which has not yet been ratified and signed by the President, but is expected to become effective in early 1998) will add additional penalties for rollovers (discussed below) from a regular IRA that are withdrawn early. So if you are planning on taking advantage of the IRA rollover provisions, you must be very careful that you do not violate the early withdrawal restrictions.

Other payout rules: Distributions from a Roth IRA will not be subject to the required distribution rules of Code Sec. 401(a)(9)(A), or the incidental death benefit rules of Code Sec. 401(a).

Rollovers: Rollovers to a Roth IRA from either a non-Roth IRA or another Roth IRA are allowed only if they are qualified rollover contributions, i.e., those that meet the Code Sec. 408(d)(3) requirements (60-day rollover rules). A qualified rollover from one Roth IRA to another Roth IRA is tax-free and can be made regardless of the taxpayer's AGI. However, qualified rollovers from a non-Roth IRA to a Roth IRA, or conversions of non-Roth IRAs to Roth IRAs, are:

...treated as taxable distributions (but aren't subject to the 10% penalty tax on pre-age-59-1/2 distributions); and

...can't be made if the taxpayer's AGI for the year exceeds $100,000, or he is a married individual filing a separate return for the year.

Taxpayers who make qualified rollovers from non-Roth IRAs (or convert the accounts to Roth IRAs) before Jan. 1, '99, can spread out the tax they owe as a result of the distribution over 4 tax years beginning with the year that the distribution takes place.

Planning Suggestion: