Helpful Tip: Moving Funds to a Roth IRA

Recently, I wrote about the opportunities and potential pitfalls of employing a Roth IRA conversion strategy. In a previous article for those who otherwise would not qualify due to income limitations, I also presented a back-door way to get money into a Roth IRA. Although these techniques require careful thought and analysis, I can also present a much simpler way to take advantage of Roth IRAs that is often overlooked.

Not everybody qualifies to contribute to a Roth IRA, as there are income limitations and you must have earned income (either person if married). I’ve often found that people do not contribute, even though they could and should.

One reason some people delay action is that they mistakenly believe that they aren’t allowed to contribute to an IRA if they also have a retirement account at work, such as a 401(k). In fact although there are some restrictions, most workers are permitted to use a Roth IRA in addition to their employer provided plan.

One advantage of the Roth IRA compared to the traditional deductible IRA is that the income limitation is much lower. The ability to use a deductible IRA starts to phase out at an income level of $55,000 for an individual ($89,000 for married filing jointly). In contrast, an individual can earn up to $105,000 ($166,000 married filing jointly) and can still get the full benefit of a Roth IRA. This lower threshold, along with the other features of a Roth IRA, makes it a great compliment to your retirement plan at work.

A frequent reason many people give for not using a Roth IRA is that they can’t afford to save more. If they are already socking away as much for retirement as they can handle, this is a logical justification. However, many people have money sitting in another location - such as a bank account or a regular mutual fund – which could be used to fund a Roth IRA. The simple act of moving money from one account to another can shift assets from a taxable to a tax-free status.

Future growth in a regular account will be taxed, thus reducing your investment return. Contrast this to a Roth IRA whereby all future gains will be tax free. Just think of having money growing for many years without the drag of taxes and of the long term benefits to you or your heirs!

Each qualifying individual is allowed to contribute $5,000 in 2009 ($6,000 for people age 50 and older). Even if you’ve already filed your 2009 tax-return, you can still contribute to a Roth IRA until April 15, 2010. There is no deduction to alter the tax calculation, so you would not need to revise or amend the tax return. Therefore, if it makes sense in your situation, you still have time to use this method. Further, if you are confident that you will qualify in 2010, you could also fund two years at once and double the benefit.

If you qualify for a Roth IRA and have a source of funds, you should consider taking advantage of this excellent retirement planning method. Moving funds to a Roth IRA is one case where moving money from one pocket to another does much more than just stir up a little lint.