The Foreign Service Journal, December 2003

contributions to a Traditional IRA hinges on whether you or your spouse is an active participant in an employer- sponsored retirement plan. If neither of you is an active participant, the con- tributions should be tax-deductible. If one or both spouses do partici- pate in an employer-sponsored retirement plan, that can limit the deductibility of your Traditional IRA contribution, depending on your modified adjusted gross income for that year. If your joint MAGI is $150,000 or less, contributions are tax-deductible up to the maximum level. If your MAGI exceeds that limit, your spouse’s active participa- tion in a qualified plan will affect the deductibility of your Traditional IRA contribution. (But you are still eligi- ble to make a non-deductible contri- bution to your spouse’s IRA account up to the limit.) Withdrawals from a Traditional IRA, regardless of whether contribu- tions are deductible or non- deductible, prior to age 59 1 / 2 are gen- erally subject to a 10-percent early withdrawal penalty. However, the fol- lowing are exceptions to the penalty: death or disability, withdrawals made as a series of substantially equal peri- odic payments commonly referred to as 72(t) distributions; withdrawals used to pay unreimbursed medical expenses exceeding 7.5 percent of adjusted gross income; withdrawals used by qualified unemployed per- sons to purchase qualified health insurance; withdrawals used to pay qualified higher education expenses, or withdrawals used to pay for quali- fied first-time homebuyer expenses ($10,000 lifetime limit). Note that withdrawals from a Traditional IRA must begin by April 1 of the year following the calendar year in which the IRA owner reaches 70 1 / 2 . Roth IRAs have been well- received since their introduction six years ago as part of the Taxpayer Relief Act of 1997. They have several impor- tant features that may offer significant tax savings to retirement savers: no federal income tax on qualified distributions, certain penalty-free withdrawals, the ability to continue contributing after age 70 1 / 2 , and no required distributions after age 70 1 / 2. The Economic Growth and Tax Relief Reconciliation Act of 2001 made Roth IRAs even more attractive. The maximum amount one may con- tribute to a Roth IRA has been increased and additional catch-up contributions may be made by investors over age 50. Unlike the Traditional IRA, Roth IRA contributions are always non- deductible; however, the Roth IRA is only available to individuals who meet certain modified gross adjusted income requirements. Single taxpayers can make an annu- al contribution of up to $3,000 of earned income to a Roth IRA if their MAGI is less than $95,000, or a partial contribution if their MAGI is between $95,000 and $110,000. Married taxpayers filing jointly can make annual contributions of up to $3,000 each if their joint MAGI is less than $150,000 and the combined earned income of both spouses is at least the contributed amount. They can make partial contributions if their MAGI is between $150,000 and $160,000. Married taxpayers filing separately can make partial contributions if their MAGI does not exceed $10,000. Earnings from a Roth IRA may be free from federal income tax and penal- ties if certain conditions are met. For distributions to be qualified, the Roth IRA must exist for a minimum of five years after the first tax year for which a contribution was made and must either be made after age 59 1 / 2 , due to death or disability, or made for qualifying first- time home-buyer expenses (up to a $10,000 lifetime limit). Withdrawals from Roth IRAs that do not meet the requirements for qualified distributions can be included in income to the extent of earnings on contributions; however, contributed amounts are always distributed before investment earnings. Thus, you can withdraw up to the aggregate amount of your contributions at any time, for any reason, free from federal income tax and penalties. All non-qualified withdrawals beyond cumulative con- tributions will be subject to both ordi- nary federal income taxes and a 10- percent early withdrawal penalty. Unlike Traditional IRAs, people who continue to work after age 70 1 / 2 can still make Roth IRA contributions, provided they have sufficient earned income to qualify. This is particularly valuable if you do not wish to distrib- ute assets from your tax-favored IRA at that age. How can I get the best of both worlds? You are always free to invest in both a Roth IRA and a Traditional IRA, but the combined annual contribution cannot exceed $3,000 for an individ- ual, or $3,500 with the catch-up provi- sions. Thus, as mentioned previously, the total for a wage earner and his spouse could reach a maximum of $7,000 through 2004 if both are age 50 or above. A common question concerns the conversion of a Traditional IRA, either deductible or non-deductible, into a Roth IRA. One is eligible to do this if the single or joint adjusted gross income of the account-holder(s) is $100,000 or less (not including the funds used in the rollover). However, married persons filing separately can- not convert to a Roth IRA. Note that ordinary federal income taxes will apply to the amount of the conversion. In addition, while any applicable 10-percent early withdrawal penalty does not apply to converted amounts, the dollars paid in taxes may also be subject to that penalty if one D E C E M B E R 2 0 0 3 / F O R E I G N S E R V I C E J O U R N A L 21 F S F I N A N C E S