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Roth IRAs:The Deal of the Century?
By Lee Matthew / Illustration by Robin McClannahan
THE ROTH IRA. It's been touted as the deal of the century, but what is it? Is it a good deal for everybody in general? For you in particular? Now is the time to get the information you need to make a good decision, because the end of 1998 will be here before you know it.
1. What is a Roth IRA?
Named for its sponsor, Sen. William Roth of Delaware, the Roth IRA was created as part of the Taxpayer Relief Act of 1997. The Roth IRA differs from a traditional IRA primarily in how it is taxed. As you probably know, contributions to a traditional IRA may be tax deductible, and any earnings are taxed as income when you make withdrawals at age 591/2 or later. The Roth IRA turns this tax picture around completely: contributions are not tax deductible, and any earnings withdrawn after five years and age 591/2 are tax free.
Contributions. Your total contributions to all IRAs, including both traditional and Roth, are limited to $2,000 per year of earned income ($4,000 for you and your spouse). You may contribute to a Roth IRA even if you are already participating in an employer-sponsored or self-employed retirement plan. You are fully eligible to contribute to a Roth IRA if you earn up to $95,000 a year for individuals, $150,000 a year for married couples. Eligibility phases out at $110,000 and $160,000, respectively.
Withdrawals. With a traditional IRA, you must start making at least minimum withdrawals by age 701/2; with the Roth IRA, there are no mandatory withdrawals at any age. However, you may withdraw from a Roth IRA without tax or penalty when the account has been open for five years and you are 591/2 or older. You may withdraw your contributions at
any time, but withdrawals of earnings before age 591/2 may be subject to tax and a 10 percent IRS penalty. There are exceptions, though: In cases of death, disability or a first-time home purchase, you may withdraw Roth IRA assets without penalty, up to a lifetime limit of $10,000.
Converting your existing IRA. If your adjusted gross income is less than $100,000, you may convert your existing IRAs to a Roth IRA by paying income tax on the untaxed portion of your traditional IRA. If you convert before the end of 1998, you may spread the tax over four years. Like the contributory Roth IRA, the potential earnings in your converted Roth IRA are not taxed.
However, the decision to convert is not necessarily a simple one. Ask your tax adviser or financial planner to run some conversion software for you, using a couple of different scenarios. Discuss the following: Would you be able to pay the tax without tapping the IRA assets? What do you think your tax bracket will be in retirement? Would conversion make sense as a tool in your estate planning?
2. What's in it for me?
The three main advantages of a Roth IRA are (1) the potential tax-free growth of your nest egg, (2) the fact that you are not required to start making withdrawals at age 701/2, and (3) its use as an estate planning tool. Potential tax-free growth. The fact that potential growth in the Roth IRA can be tax free makes it an exceptional deal as an investment. Giving up the current-year tax deduction you might have gotten by contributing an equivalent amount to a traditional IRA or 401k is the price you pay for potentially greater after-tax annual income in retirement. It would be ideal to fully fund your employer plan as well as a Roth IRA, but if you can't afford both, you might consider diverting some of the contributions not matched by your employer over to a Roth IRA.
Later withdrawals. If you're not planning to use your IRA as an immediate source of income in retirement, the Roth IRA has the great advantage of allowing you to leave the money in the IRA as long as you like, while it continues to potentially grow, tax free.
Estate planning. In fact, you are never required to withdraw from your Roth IRA, so you may leave it to your heirs untouched. Any distributions made from the Roth IRA to your heirs are income-tax free (although the account may be subject to estate tax). The Roth IRA may be used together with trust arrangements to minimize taxes and lengthen the period of potential tax-free growth; see your adviser. Furthermore, it may make sense to convert existing IRAs to a Roth IRA, reducing your estate by the amount of the tax and potentially lowering your estate tax bill; again, see your adviser.
3. How do I open a
Like a traditional IRA, a Roth IRA may be established at a bank, a mutual fund company or a brokerage house. An IRA of any kind is a custodial account that can hold a variety of investments -- money markets, CDs, mutual funds, individual stocks and bonds. So it's probably best to decide what investments you want to put in your Roth IRA first, then open the account at an institution that offers you a good selection of choices that are suitable for you. If you're unsure, talk to a reputable financial planner.
While your tax adviser or financial planner is the best person to consult about your individual situation, online advice and information are available at the Roth IRA Web Site, at http://www.rothira.com. Here you'll find a number of current articles, as well as books, tapes and software.
*
Lee Matthew is a financial planner in Albuquerque.
Important dates
Contributory Roth IRAs for 1998: Set up by 4/15/99.
Conversion Roth IRAs for 1998: Set up by 12/31/98.
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SAGE October, 1998
The Deal of the Century?
Here are some facts that may help as you consider the pluses and minuses of setting up your own Roth IRA:
Roth IRA?
