How to Fund a Roth Account

Congress passed the Tax Payers Relief Act in 1997. With it, the Roth IRA emerged as a tax-free supplemental retirement account structure. While the Roth IRA follows all rules and regulations of traditional IRA accounts, the Roth has special caveats as well. After-tax dollars fund the Roth IRA, not pre-tax dollars. However, the contributions and earnings grow tax free. In addition, you must hold the Roth IRA for five years before taking distributions. You can fund your Roth IRA by either converting a traditional IRA to a Roth IRA, or by funding a new Roth IRA with earned income.

Instructions

1. Convert an existing traditional IRA into a Roth IRA. You must pay taxes on the funds in the traditional IRA when you convert. For conversions in 2010, you may stretch conversion taxes over 2011 and 2012. The entire amount that is converted is split in half and added to ordinary income in each of the next two years.

2. Open the Roth IRA account with a new custodian. Open a separate account rather than a contributory account, if you are converting a traditional IRA, to ensure nothing is viewed as an over-contribution or taxed twice. A converted Roth IRA should have that as part of the title, "XYZ Brokerage Custodian for benefit of Jane Doe Roth Conversion IRA." Fill out transfer and conversion paperwork for a conversion. The custodian will transfer the assets.

3. Fund non-converted Roth accounts with earned income. The 2010 contribution limit is $5,000, or $6,000 if you are over age 50. Anyone can fund the Roth IRA as long as the IRA owner has had at least that amount in earned income for the year of contribution.

Tips & Warnings

• Single tax filers must earn less than $105,000 annually to contribute to a Roth IRA; there is a phase-out limit of how much you can contribute if you earn between $105,000 and $120,000. Married couples must earn less than $167,000 but not more than $177,000 for the phase-out section.

• The IRS allows many types of investments in IRAs, but doesn't require custodians to offer every one. Choose the custodian that offers the investment options you want for your Roth IRA: bank time certificates, securities, real estate or precious metals, for example

References

• IRS: Roth IRAs
• Money-zine: Roth IRA Contribution Limits
• Roth IRA: Introduction to Roth IRAs