To Roth or not to Roth, that is the question...

[cute fuzzy bunny]

Those of us without earned income (aka, a paycheck) can still contribute to Roth IRA's, although you have to pay a 6% "excise tax" on the contributions you make.

Whats the take on this? Is it worth it to basically pay a 6% front load on a roth? Considering i'm 42 and having some time before I'd be withdrawing, would an investment in a roth in something like vanguards TIPS fund make any sense at all? Its not like its a huge sum of money, $180 a year for a $3000 investment.

Whats that anyway, about 90 boxes of dryer sheets?

I'm somewhat pressed to make this decision after convincing my girlfriend to open a roth and making a sympathetic equivalent investment, only to discover while doing my taxes that the IRS doesnt consider any of my income 'earned'.

Funny, I thought I earned it. I dont remember the money fairy showing up and dropping off a bag of cash.

Anywho, I can either withdraw the money now before the april filing deadline with no particular penalties as an "oops" and simply take the small short term gain, or pay the 6% "excise tax".

What thinks all of you?

 

[wabmester]

Re: To Roth or not to Roth, that is the question..

You've just experienced the girlfriend tax.  If you two were married, she'd be able to fund a spousal IRA for you out of her earned income.

Pay the excise tax.  6% seems like a bargain for a lifetime of tax-free earnings.   After your post, I'm sitting here trying to understand why I shouldn't put *all* of my money into a Roth and pay the 6%.

 

[wabmester]

Re: To Roth or not to Roth, that is the question..

Never mind. I just read that the excise tax is for every year! Withdraw! Withdraw!

 

[cute fuzzy bunny]

Re: To Roth or not to Roth, that is the question..

Ah apparently I need to learn to read.

I thought the excise tax was a one time thing.

At that it sort of seemed like a good deal.

Paying it annually? Why dont they just put a thing in there that says "If you put excess funds in a roth ira, withdraw them immediately or we will send two large ugly men to beat you senselessly about the head and the shoulders until you expire, after which you will owe several death taxes".

Why not make it simple to understand?

Just whatever you do, dont mention that girlfriend tax thing and the implications of marriage. She doesnt need any further ammunition. I'm hanging onto my bachelorhood by the skin of my teeth.

 

[unclemick]

Re: To Roth or not to Roth, that is the question..

Wow! Once again I've learned something -?what are some things I might think are 'earned income' that the IRS would not allow or do they decide after the fact.

And here I thought they would just say "dats a no no" with no harm no foul - and no 6% ding. Boy am I a dummy - after all it is the IRS.

 

[cute fuzzy bunny]

Re: To Roth or not to Roth, that is the question..

In short its just monies you receive while working, either paid by another person or by a company.

Wages, salaries, bonuses, tips (not THOSE tips), etc. No investment income, dividends etc. If it is reported on a W-2, its earned income, on a 1099 its investment income.

 

[cute fuzzy bunny]

Re: To Roth or not to Roth, that is the question..

I briefly thought about the concept of reporting $3k in miscellaneous non-w2 income, paying the $64 income tax on that, and using that earned income to fund the Roth.

I doubted the IRS would complain much about my paying them taxes on money I didnt actually make, but then decided that I dont look good in orange and prison food isnt that good.

On the other hand I did enough odd jobs for friends and family where they paid for the materials and I performed the labor. It wasnt formally "pay" but certainly more than $3000 changed hands. Actual cash profit to me didnt formally happen but...

Nah.

 

[wzd]

Re: To Roth or not to Roth, that is the question..

If it is reported on a W-2, its earned income, on a 1099 its investment income.

Except (the favorite word in the tax code, I think), most 1099-misc income is considered self employment income, or sometimes rental income (from state/federal assisted parties). For self employment income, you have to pay both the employer and employee share of SS, which used to be about 14%.

Wayne

 

[Red-y]

Re: To Roth or not to Roth, that is the question..

One additional bit of information about the excess Roth contributions in a year:

While true that if you don't withdraw the excess contributions before the date your tax return is due, you may owe the 6% excise tax, I believe there is another "out" you can take if you will also have earned income the NEXT tax year.

To wit, you can apply the excess contributions to your next year's Roth IRA contribution. I inadvertantly ran afoul of the income limitations for single filers with my Roth IRA in 2003, contributing the full $3000 at the beginning of the year. I sold some rental property and the capital gains pushed me into the gross income range where my Roth contribution is limited.

But doing the research in Publication 590, "Individual Retirement Arrangements," I read "If contributions to your Roth IRA for a year were more than the limit, you can apply the excess contribution in one year to a later year if the contributions for that later year are less than the maximum allowed for that year."

I'm a technology manager in my day job (for two more years), but I moonlight at H&R Block doing taxes. That will be my vehicle for easing into retirement with a part-time, seasonal job.

Cheers,
Red-y