Military Financial Advice - Military Times

How to make Roth IRAs work for you

All pay, including regular pay and special allowances, is tax-free while a service member is serving in a combat zone.

Use this benefit to your advantage by converting some or all of your regular individual retirement accounts to a Roth IRA account. If your taxable income is low enough, you'll get a federal tax refund of up to $1,000 when you make a $2,000 contribution to a retirement plan.

Roth IRA benefits

• Tax-free growth. Contributions to a Roth IRA are not deductible, but your Roth IRA growth is tax-free, and at age 59½, you can take tax-free distributions.

Tax-free distributions also are available in the case of death or disability before age 59½ and for a qualified first-time home purchase. The account must be held for five years, starting with the first contribution. In contrast, a regular IRA usually is taxable when distributions are made.

• Tax-free distributions. Unlike a regular IRA, where distributions must start when the account owner reaches age 70½, the Roth IRA does not require distributions except upon death. Even then, you can leave the account to your spouse or children, and they can take distributions over their life expectancy, also tax free. Distributions to your children after your death can be used without paying any tax on the money distributed from your Roth IRA account.

• "Retirement Insurance." If you live to your 90s, you may need extra money for living expenses. If you have a substantial Roth IRA, you will have a source of tax-free retirement income -- for example, if your account grows for 20 years at a rate of 7 percent, you will have four times the amount at age 90 that you did at age 70.

If you keep working after age 70, you can continue to contribute to your Roth IRA and let the account balance grow as long as possible.

Like the regular IRA, the current maximum contribution to a Roth IRA is $3,000 for 2004 ($3,500 if you are 50 or older). In 2008, the maximum contribution is slated to increase to $5,000 ($6,000 if over 55) and will be adjusted for inflation.

Roth IRA conversions

If you have regular IRAs, you can convert these accounts to a Roth IRA account.

The downside to conversion is that the amount converted from your regular IRA account balance will be taxable in the year of conversion. The upside is that the investments will be in a Roth IRA account and never will be taxed again, nor will the appreciation after conversion. To do a Roth IRA conversion, you must have an adjusted gross income (line 34 on your 2003 1040 tax form) of less than $100,000.

The example in the chart above shows the federal tax return of a single E-5 with three years of service deployed to Iraq on April 1, 2003. This service member does not own a home. In 2003 he converted his entire regular IRA balance of $7,000 to a Roth IRA and contributed $2,000 to his new Roth IRA account.

Since this service member was deployed to a combat zone, he was able to convert his regular IRAs to a Roth IRA without paying taxes on the conversion.

In addition, he received a refund of all federal taxes paid in 2003 since he was eligible for the federal retirement savings tax credit.

Since state taxes are calculated differently from federal taxes, a small amount of state taxes may be due, depending on his state of residence.

Savings contribution credit

If you have a low adjusted gross income and make a retirement plan contribution of $2,000, you will receive a federal tax credit of up to $1,000.

The federal tax credit is 50 percent of the first $2,000 for single taxpayers with adjusted gross incomes less than $15,000. For adjusted gross incomes between $15,001 and $16,250, the credit is 20 percent. And if your adjusted gross income is between $16,250 and $25,000, the credit is 10 percent.

Credits are available for low-income married taxpayers as well. These credits range from 50 percent of the first $2,000 contributed to a retirement plan (IRAs, 401(k) plans, Thrift Savings Plans and other retirement plans) for adjusted gross income below $30,000, 20 percent between $30,001 and $32,500 and 10 percent from $32,501 to $50,000.

Each person's tax situation is unique. Consult your tax adviser for assistance with tax planning.

Barbara H. Pietrowski is a licensed certified public accountant, certified financial planner and personal financial specialist. Her practice includes tax preparation, fee-only financial planning and investment management. Her office is in Kensington, Md. She can be reached at barbarapietrowski@yahoo.com.