Mom's Roth IRA contribution 2010

[Ronnieboy]

My mom (69 years young) is retired, she is paid some alimony from my father. I am going over to her house tonight to help her set up a Roth IRA through Vanguard and also move over some other accounts to consolidate everything.

One of the questions that I have is the requirement of the contributions being in the Roth IRA for 5 years before she can withdrawal earnings tax free. How does the IRS decide the taxable earnings part?

Lets say she puts in $6k for 2010, then in 2 years has to withdraw $2k, can't she just say that withdrawal is all from her contribution and not from her earnings until the 5 years have passed?

Secondly, is a Roth the proper vehicle for her to use? I am thinking her income will go up over the next couple of years since she will have to take RMD on her 'annuity' type of investment.

 

[Gus.]

You said that she is paid "some alimony". Is that her only source of earned income? Remember that you have to have earned income to contribute to an IRA. If her alimony is less than $6,000 she won't be able to make the full $6,000 IRA contribution. Investment income, interest, annuity payouts, etc. don't count as earned income.

 

[Alan]

see IRS publication 590 which gives the order of distributions. In the example you give, the $2k she withdraws will not be taxable as it will be treated as a return of contribution.

If you receive a distribution from your Roth IRA that is not a qualified distribution, part of it may be taxable. There is a set order in which contributions (including conversion contributions and rollover contributions from qualified retirement plans) and earnings are considered to be distributed from your Roth IRA. For these purposes, disregard the withdrawal of excess contributions and the earnings on them (discussed earlier under What if You Contribute Too Much ). Order the distributions as follows.

1. Regular contributions.
2. Conversion and rollover contributions, on a first-in first-out basis (generally, total conversions and rollovers from the earliest year first). See Aggregation (grouping and adding) rules, later. Take these conversion and rollover contributions into account as follows:
   1. Taxable portion (the amount required to be included in gross income because of the conversion or rollover) first, and then the
   2. Nontaxable portion.
3. Earnings on contributions.

 

[rescueme]

I am thinking her income will go up over the next couple of years since she will have to take RMD on her 'annuity' type of investment.

Not necessarily. If it is a "life annuity" (e.g. payable for the remainder of her life, and not just a specific term), it may not be considered for RMD purposes at all. You may have to talk to the contract holder to determine this.

As an example, DW/me have an SPIA that is a life annuity. It will give us payments for the rest of our (one/both) lives with no restriction. The TIRA funds I used to purchase it are removed from RMD consideration (one of the reasons we purchased the product, among others).

Again, you will have to determine the form of the annuity...

 

[Ronnieboy]

You said that she is paid "some alimony". Is that her only source of earned income? Remember that you have to have earned income to contribute to an IRA. If her alimony is less than $6,000 she won't be able to make the full $6,000 IRA contribution. Investment income, interest, annuity payouts, etc. don't count as earned income.

She is paid over the $6k so she should be good on that part, but it is all alimony as far as that is concerned. From what I can tell all the alimony is considered earned income...

 

[Ronnieboy]

Not necessarily. If it is a "life annuity" (e.g. payable for the remainder of her life, and not just a specific term), it may not be considered for RMD purposes at all. You may have to talk to the contract holder to determine this.

As an example, DW/me have an SPIA that is a life annuity. It will give us payments for the rest of our (one/both) lives with no restriction. The TIRA funds I used to purchase it are removed from RMD consideration (one of the reasons we purchased the product, among others).

Again, you will have to determine the form of the annuity...

I am not actually sure what type of product she has, she did this on the advise of one of her friends "who has 'so and so' looking after her money and she had done quite well".

Come to find out it is some kind of deal where $XX,XXX was moved out/rolled over from her 401k. She cannot touch the money for 10 years (without penalty) but during that 10 years she gets a guaranteed 6% return or the actual cash value of her account which ever is better. After that 10 years (which is is into about year 6 or 7) she can take lump sum or pension type payments. She was told by the person overseeing her account that she will have to take RMD by 70 1/2 so I am thinking it is still considered some type of qualified retirement account.

As far as how the product has gone, based on the guaranteed 6% return she is about $20k above what he cash value is at as of now. The cash value is about $20K above the amount she rolled over (due to the drop and return of the stock market).

 

[rescueme]

From what I can tell all the alimony is considered earned income...

As long as it is set up as a court order, and is taxable. Here's an article, but you may want to get an "official" ruling:

What Is Considered Qualified Earned Income for Roth IRA? | eHow.com

 

[Alan]

She is paid over the $6k so she should be good on that part, but it is all alimony as far as that is concerned. From what I can tell all the alimony is considered earned income...

I'm pretty sure that alimony is counted as allowable compensation to determine if she can contribute to a Roth IRA.

Compensation Income

For each year you contribute to a regular IRA or a Roth IRA, you (or your spouse, if you file jointly) must have qualifying income. If you don't have qualifying income, you can't contribute. And if your qualifying income (together with qualifying income of your spouse that can be used to support your contribution) is less than the maximum contribution, then the amount you can contribute is reduced.
There are three categories of qualifying income:

• Amounts earned as an employee,
• Self-employment income, and
• Alimony income.

 

[Ronnieboy]

see IRS publication 590 which gives the order of distributions. In the example you give, the $2k she withdraws will not be taxable as it will be treated as a return of contribution.

Thanks,

So in essence you can continually put money in and take money out without ever hitting the tax trap if you only take out contributions.

Year 1-contribute $6k
2- contribute $6k
3- contribute $6k, withdrawal $5k
4- contribute $6k, withdrawal $5k - rinse, repeat

 

[Alan]

Thanks,

So in essence you can continually put money in and take money out without ever hitting the tax trap if you only take out contributions.

Year 1-contribute $6k
2- contribute $6k
3- contribute $6k, withdrawal $5k
4- contribute $6k, withdrawal $5k - rinse, repeat

That is how I read the IRS publication, but you may want to ask the same question at Fairmark.com

 

[kaneohe]

That is how I read the IRS publication, but you may want to ask the same question at Fairmark.com

I agree w/ Alan. Be sure to keep the 5498s that will document contributions and be sure to file Form 8606 when you start withdrawals.....see pt IV on the 2nd page http://www.irs.gov/pub/irs-pdf/f8606.pdf

 

[Ronnieboy]

UPDATE:

I went over and helped my mom open up a ROTH at Vanguard. We are also going to transfer the $$ he has in a Roth at Janus funds to Vanguard, they (Vanguard) are about 0.5% less expensive for the fund we are setting up.

I did find out that she has $30ish grand in Series EE bonds, they are between the years 1994 and 2006 or 7. Most of them are earning 1.5% interest, some are 3.6 and she even has some at 4%.

I am figuring it is worth it for her to cash the 1.5% bonds even though they are not at maturity and stick them in a 5yr cd at the local credit union, which has a flexible CD earning 2.5%. It is flexible in the fact that she can cash the CD before maturity without penalty if she does it within a specific 5 day time frame each quarter.

Is cashing them in for the 2.5% flexible CD reasonable? When CD rates start to go up she can cash them in and put them in higher amounts.

 

[kaneohe]

You might want to see if those 1.5% bonds are eligible for the 2x-20yrs feature.
That effectively makes the yld more like 3.6%. Double check w/ US Treasury to be sure.
How Series EE Savings Bond interest rates work: US Savings Bonds