The Roth IRA, named after Senator William Roth of Delaware, was introduced with the passage of the Taxpayer Reform Act of 1997. Effective for tax years beginning in 1998, the Roth IRA has the same contribution limits as Traditional IRA's, but has different distribution rules that are very advantageous to many investors.

Contributions to a Roth IRA
All contributions to a Roth IRA are nondeductible or "after-tax." Although the ability to take a current tax write-off is not available, the benefit of contributing to a Roth account is that earnings are tax-free when withdrawn, generally after age 59½. In other words, investment earnings are tax-exempt rather than just tax-deferred.

In order to contribute to a Roth IRA, an individual must meet the same requirements for taxable compensation from wages, salary, self-employment income, alimony, and so forth, as with a Traditional IRA. However, there is no limitation on contributing after reaching age 70½, so seniors who meet the income requirement may still make IRA contributions into a Roth account. The IRS does limit eligibility for contributing to a Roth to those whose incomes are under certain levels, though. A single person can contribute $2,000 to a Roth IRA if their adjusted gross income is below $95,000, and can make a partial contribution if their income is between $95,000 and $110,000. Married couples filing jointly can make a full contribution if their AGI is below $150,000, with partial contributions permitted at income ranges between $150,000 and $160,000. Married couples filing separate tax returns are only able to contribute to a Roth IRA at AGI levels under $10,000. Participation or coverage in an employer-sponsored retirement plan does not affect contributing to a Roth in any way.

If an individual is only eligible to make a partial contribution to a Roth IRA, the difference (up to the $2,000 total limit) can be contributed to a Traditional IRA, regardless of whether that amount is deductible or nondeductible. The IRA contribution limit remains at $2,000 per taxpayer, not $2,000 per IRA type.

Roth IRA Conversions
Another way to establish a Roth IRA is by a rollover from a Traditional IRA, referred to as a conversion. In doing so, the entire amount of the conversion is taxable, excluding any nondeductible contributions that had been made to the Traditional IRA. Conversions are taxed as ordinary income, and depending on the amount converted, it is important to be aware that an individual could be pushed into a higher tax bracket. The early withdrawal penalty of 10% does not apply to Roth conversions. To be eligible to convert to a Roth IRA, AGI must be under $100,000 (not including the amount being converted) for either single filers or those who are married filing jointly. Married couples filing separately are not eligible to do Roth conversions. Any amounts converted to a Roth from an existing IRA do not count toward the $2,000 annual contribution limit. However, only IRA's (including SEP and SIMPLE IRA plans) can be converted to Roth accounts, not employer-sponsored qualified retirement plans, such as 401k plans or Profit Sharing plans. Minimum required distributions from Traditional IRA's are also not eligible to be converted.

Roth Deadlines
Contributions to a Roth account must be made by the tax-filing deadline of April 15, with no extensions permitted. However, the IRS has provided for the ability to undo or change the nature of conversions or contributions. For example, if an individual finds that they were not eligible to fund a Roth IRA after having done so, they can recharacterize the contribution plus its earnings to be a Traditional IRA contribution, and vice-versa. They can also recharacterize a conversion from a Roth account back into a Traditional IRA, whether due to ineligibility or otherwise. IRS regulations grant an automatic extension of six months from the unextended due date of a tax return to complete a recharacterization. In many cases it may be necessary to amend the tax return after a recharacterization has been processed.

In 1998 and 1999, some investors recharacterized and reconverted their Roth IRA's multiple times in an effort to reduce their conversion tax liability at lower market values. Effective beginning in the year 2000, the final regulations for the Roth limit reconversions to one per calendar year, and also prohibit reconversions in the same year as the conversion.

Roth Withdrawals
Distributions from a Roth are entirely tax-free if the following two requirements are met:

• It has been at least 5 years since the tax year for which a Roth contribution or conversion was initially made, and
• The IRA owner is at least age 59½, is disabled or has died, or is a "first-time home buyer." The first-time home purchase exception is limited to $10,000, and is available if the IRA investor has not owned a home for at least two years.

While not tax-free, other withdrawals prior to age 59½ may be penalty-free, such as distributions used for higher education expenses, medical expenses in excess of 7½% of AGI, and all other exceptions that apply to Traditional IRA withdrawals.

Unlike the Traditional IRA, Roth annual contributions of up to $2,000 can be withdrawn at any time without tax or penalty. In fact, at any time distributions are made from a Roth IRA, special "ordering" rules apply. Money withdrawn from Roth accounts comes out in the following order:

• Annual contributions
• Converted amounts that were taxable
• Converted amounts that were not taxable (from nondeductible Traditional IRA contributions
• Earnings

Also in contrast to the Traditional IRA, Roth IRA's are not subject to minimum required distributions at age 70½. Roth IRA assets are still subject to estate taxes, but potentially may be transferred to beneficiaries free of income tax.

One of the reasons behind the legislation that created the Roth IRA was to encourage Americans to save more. Its features of tax-free earnings and access to contributions often make it a better retirement planning tool than the Traditional IRA. Pending legislation may increase AGI limits for contributions and eliminate AGI caps for conversions to make the benefits of the Roth IRA available to more and more investors. There are also proposals in Congress of adding Roth features to 401k plans, which would allow for after-tax contributions and tax-free withdrawal of earnings at retirement from these plans as well.