Safe Harbor Seed Roth: Open One Now?

A Roth provides tax-free retirement income, but how do you navigate the tough five-year rules to open one?

Want tax-free lifetime income? Can’t convert to a Roth IRA in 2012 because you’ll be over the income limit? Open a Roth account before April 15, 2012 with as little as $1 and start a miracle. The IRS recognizes the start date as January 1 of either the current or prior tax year – 2011, not the day you opened the account. It’s your choice. Since you must own a Roth, any Roth, for five years before you can take all funds tax-free, you gain a year by using 2011 as your start date.

2012 Roth IRA Income Limits

Those who opened a Roth for 2011 get a one year head start. They will be able to take tax-free funds out a year sooner than those who wait till 2012. Accounts opened in 2011 count even if their original Roth has $1 in it. The IRS says the birth date of your first still existing and funded Roth account sets the start date – and the clock ticking on the 5 year rule. It’s a safe harbor. What if you were over the income limit for 2011 and still want a Roth IRA?

The back door was left unlocked: Can’t contribute today because you earn more than the Roth IRA income ceiling? Consider contributing to a Roth IRA within your 401k or 403b plan. Don’t have one? Ask you benefits manager to set one up. What’s the advantage? No income ceilings apply and contributions are allowed up to employees’ current plan year deferral limits ($17,000 after 2011) plus up to $5,500 for participants age 50 or more. Done right, employees can take money out tax-free in retirement, and unlike regular IRAs, there’s no required minimum distributions – ever. Employers may also match worker elective deferrals (contributions). Although all of this is currently taxable earnings, you can reduce your taxes by proportioning some of your retirement savings to your tax-deferred 401k too. 401k Roth accounts and Roth IRAs each have independent 5 year rule clocks. If you roll your 401k to a new Roth when you retire or leave employment, it starts a new 5 year clock ticking on that day. You’ll have to wait till it matures regardless of your current age or how long you held a Roth 401k. Assuming you started a Roth IRA over five years prior, at retirement, a Roth IRA has a big advantage: It provides former workers substantial tax-free benefits for life. The 401K contribution deadline is December 31.

Start your safe harbor seed Roth IRA today and you’ll smile tomorrow.