Your Tax Questions Answered
Taking Retirement Contributions
To the Max
Kiplinger editorial director Kevin McCormally and fellow tax experts Peter Blank and Mary Beth Franklin tackle your most pressing tax challenges
By Kevin McCormally, Editorial Director, Kiplinger.com
January 27, 2010
QUESTION:
I'm really confused about the relationship between max 401(k) contributions, max Roth IRA contributions, and catch-up contributions (over 50). For 2010, can an individual over 50 years old contribute a total of $16,500 + $5,500 (401(k) catchup) to their 401(k), plus $5,000 + $1,000 (Roth catchup) to their Roth IRA, for a total of $28,000 (assuming the individual is not bound by various limits)? I thought I remembered reading something somewhere that says if you contribute to a Roth IRA, you can't make 401(k) catchup contributions. Is that the case?
KEVIN ANSWERS:
You can contribute the max to both a 401(k) and a Roth IRA in the same year. And, you’ve got the correct figures for 2010, which are the same as they were for 2009. Up to $16,500 to a 401(k), plus the $5,500 catch up for someone 50 and older by the end of the year, for a total of $22,000 (plus any employer matching). And $6,000 to a Roth for a 50 and older person who qualifies for the catch up. There is no connection between the Roth IRA and the 401(k) limits, so whatever your read that said you were banned from the Roth if you took advantage of the 401(k) catch up was incorrect.
QUESTION:
I am very confused about the rules for Roth IRA conversions.
I opened up a contributory Roth in the year 2000. I haven't added any further funds to the Roth, but I still have it and it performs well. I also have a traditional IRA CD (all the money is pre-tax), in which the interest currently gets rolled back into the principal. It is a multi-year CD which won't mature until 2013. I had planned to start taking out interest from the CD each year beginning in 2011. I will be 59 1/2 in October 2010, so the interest I take out beginning in 2011 wouldn't have a penalty, though it would be taxable.
As an alternative to starting to take interest from the CD beginning in 2011, I am considering converting the IRA CD to a Roth in 2010 to take advantage of the option of delaying taxes on the rollover amount to 2011 and 2012. At the time of the planned conversion, I will be 59 1/2. If I convert the traditional IRA to a Roth, will I have to wait 5 years to take out any earnings from the Roth, or will the 5-year rule be bypassed because of my previous contribution IRA? If I am still subject to the five year rule, what will happen if I take earnings from the CD beginning in 2011? Will I be subject to tax since I will not have waited the required five years? Or will the interest on the CD be considered for Roth purposes to be coming out of the initial rollover amount due to the rule which states that contribution and rollover money have to come out of a Roth before earnings?
KEVIN ANSWERS:
There’s a lot of confusion about the five year rule because there’s a lot of misinformation circulating about it.
Here’s the deal:
You’re right: If you convert your traditional IRA to a Roth, you will pay tax on the amount converted. Unless you choose to report the amount as taxable income on your 2010 return, it should be reported 50/50 on your 2011 and 2012 returns.
The five-year rule applies only to earnings in the account AFTER the conversion. Since you will be over age 59 ½, as soon as you make the conversion you can withdraw any or all of the converted amount without tax or penalty. Remember, you pay tax on the full amount (both your original contributions and all of the earnings on them up to the time of the conversion) at the time of the conversion.
The way the rules work, the first money out of an IRA are considered contributions to the Roth. So, no matter what Roth account you tap, the first money out will be considered a return of your contributions to your contributory Roth. Once you have pulled out all the contributions, you are considered to be dipping into the converted amount. And, only when that’s all gone, do you dip into earnings. And, yes, if you get to the earnings during the five year period, the earnings are taxed (but not penalized, since you’re over 59 ½).
The five-year clock on the conversion starts ticking on January 1 of the year of the conversion, even if you convert as late as December 31, so it’s possible to pass the five-year mark before 60 months have passed. The time since you made contributions to the contributory Roth doesn’t count. Each Roth conversion has its own 5-year rule.
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Reader Comments (8)
Posted by: Julie at 01/29/2010 09:34:14 AM
My husband got laid off in 2009 and received a severance package, which did not withhold any $ for the company sponsored 401K. Can we roll over the 401 to an individually managed plan and still contribute the max $ for 2009? With his severance package our income limit is too hight for a Roth, but he is 50 and we want to lower this years tax bill (he's still unemployed) which is high due to the severance package he received.
Posted by: Jim at 02/03/2010 10:55:59 AM
Last year I had mandatory retirement (57 years old for federal law enforcement) - I took all my Thrift Savings Plan money and they took 20% - had to move to another state for wife's promotion - bought new home with Thrift money along with paying medical bills, education bills, et al. - could not sell other home and have been paying two mortgages at the cost of $4300 a month - is the Thrift considered work income??
Posted by: TOM at 02/18/2010 01:51:35 AM
CAN I USE ROTH IRA MONEY TO PURCHASE INDIVIDUAL STOCKS?
Posted by: Jack at 02/18/2010 01:55:10 PM
Over 51 years old. was laid off in the beginning of 2009. Received severance with no 401K witholdings. Practically don't have anything put in savings in 2009 at all. Would like to do it on my own and put away maximum possible pre-tax amount before April 15, 2010. What are my best options? Thank you for your time.
Posted by: JP Andre at 03/14/2010 10:30:27 AM
I am considering the conversion my Traditional IRA into a Roth IRA. I also have a Rollover IRA (a 401k converted from a previous employer). I do not intend to convert the Rollover IRA. Does the Rollover IRA enter into the calculation of the taxable amount for my Traditional IRA conversion?
Posted by: EJ at 03/27/2010 04:17:07 PM
Hi, If I contribute an excess amount into a Roth IRA for year 2009 and pay the excise tax of 6% on the contribution for 2009 are there any other penalties and\or taxes when I make a qualified distribution in my retirement years? For example, if I contribute $6000 (I'm over 50) into my Roth IRA and all of the contribution is considered an excess contribution I would pay the $320 excise tax with my 1040 return for 2009. If I take a qualified distribution from my Roth IRA say seven years from now (2017) would I be required to report it as income then and\or will there be any penalties or taxes applied because the original contribution was considered excessive? Thank you
Posted by: Julian Wagner at 03/29/2010 11:30:13 AM
I am 81 and have a rollover IRA. If I convert it to a Roth in 2010 will it hold 'its' Roth status for my beneficary, i.e. can it be held beyond the five years after being inherited as a Roth or must it be converted to a stretch or sold?
Posted by: JB at 04/07/2010 11:24:02 AM
I currently have a Roth IRA I am not yet 59 1/2.In 2008, for a down payment for a first time home purchase, I withdrew approximately $10,000 from that account. At the time, I was limited in how much I could withdraw to the amount I had contributed to the Roth all earnings stayed in the account. In March 2010, I received a revised tax bill from the IRS requesting payment of the tax on this $10,000 Roth disbursement. As I have already paid the tax on the Roth contribution, and I took no earnings, do I have an argument/a prayer? Thanks!