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To Roth IRA, Just Say Yes

NEW YORK — So now you have three Individual Retirement Accounts to choose from. Or at least you will have, starting next year. Which one looks best? In almost all cases, the new Roth IRA wins the day.

In case you're wondering, it's named for Sen. William Roth Jr. — by odd coincidence, the chair of the Senate Finance Committee. (I'm collecting signatures to stop Congress from naming anything after politicians except bridges and roads.)

Whether to sign up for this IRA is a no-brainer. If you qualify, just say yes. You put away up to $2,000 annually after tax ($4,000 per couple), hold for five years, then never pay a nickel of federal tax on the money you earn — if it's spent on your first house or after you reach 59 1/2. It's also free when used if you're disabled or die.

What if you unexpectedly need money for some other purpose? Tax-free withdrawals will be allowed at any time, up to the amount you put in. Only larger withdrawals are going to be subject to tax.

The Roth IRA starts phasing out for singles with adjusted gross incomes of $95,000 and vanishes at $110,000. For couples, the range is $150,000 to $160,000. Note that all these rules are for federal tax. Whether states copy remains to be seen.

Roths (in the plural, the name of this IRA is even worse) "hold the most for long-term retirement savings," says Stephen Corrick, tax partner at Arthur Andersen in Washington, D.C. Over long periods of time, tax-free compounding is worth far more than an upfront tax deduction, he says.

You can also make annual contributions as long as you like. You're not forced to start withdrawing the money at 70 1/2, as is the case with existing IRAs.

Young people might choose a Roth IRA when they're saving for their first home. For this purpose, they can take up to $10,000 tax free, provided they've held the account for at least five years.

As an alternative to a Roth, Congress improved the existing tax-deductible IRA. You contribute up to $2,000 which grows tax deferred. But you're taxed when you take the money out and normally owe a 10 percent penalty on withdrawals prior to 59 1/2.

Deductible IRAs are for workers who don't have company retirement plans. Even if you have one, you get this deduction only if your income is lower than a specified amount.

Right now, the deduction phases out for singles whose adjusted gross income exceeds $25,000 and for married people over $40,000. The new tax law doubles these limits between 1998 and 2007, so many more people are going to be eligible.

Currently, spouses who don't have their own retirement plan are barred from deductible IRAs if their mate doesn't qualify. Starting next year spouses will qualify on their own.

You might choose a tax-deductible IRA if you don't expect to hold the investment very long.

If you already have a deductible IRA, you could roll it into a Roth if your adjusted gross income doesn't exceed $100,000. But get some advice before making this shift, James Shambo, president of Lifetime Planning Concepts in Colorado Springs, told my associate, Kate O'Brien Ahlers. You'll owe income taxes on your current, deductible account. It will take a decade or more for your Roth investment to compensate for the taxes paid, says Steve Norwitz of T. Rowe Price in Baltimore.

You can have a Roth and tax deductible IRA, if you want. But your annual contribution for both can't exceed $2,000.

The third IRA lets you invest an additional $500. It goes in an education account, naming as beneficiary a child under 18. This contribution isn't tax deductible, but it accumulates tax deferred and becomes tax free if used for higher education — a qualified trade school, community college or four-year college. Education IRAs start phasing out for singles with incomes over $95,000 and couples over $150,000.

A modest $500 a year doesn't amount to much. But each of several people — parent, grandparent, godparent, excellent friend — could apparently start a fund for a particular child, although the law isn't clear. Parents filing jointly cannot each deposit $500 for the same child, however. But they can contribute to accounts for each of their children.

If you haven't been saving, these new IRAs may give you an incentive to start.

Jane Bryant Quinn welcomes letters on money issues and problems but cannot offer individual financial advice.