For Many, Roth IRA Is Still a Good Idea
Washington Post Staff Writer
Sunday, January 3, 1999; Page H01
The bells that rang in the new year also tolled away taxpayers' last chance at a special tax break if they convert their traditional individual retirement accounts to the new Roth IRAs.
But that doesn't mean it's time to forget about the Roth. It is still available to the vast majority of Americans, and for many of them its benefits outweigh those of the traditional IRA.
Roth IRAs can be funded two ways -- by converting a traditional account, which is what has been getting all the attention, and by making annual contributions, as with a traditional account -- and both methods remain available. The deadline for 1998 contributions is the due date of your tax return, and conversions can be done any time. The only thing that has expired is a provision that allowed taxpayers to pay the taxes resulting from a conversion over four years instead of entirely in the year of the conversion.
The Roth IRA is named after Sen. William V. Roth Jr. (R-Del.), chairman of the Senate Finance Committee. Roth has long felt that a chance to accumulate tax-free savings for retirement would encourage saving among people who are put off by the strings attached to the traditional IRA.
Traditional IRAs, which have been around in one form or another since the 1970s, are funded with contributions that in many cases are tax-deductible when they are put into the account. No taxes are levied on the account's earnings as it grows. When the owner reaches retirement and begins making withdrawals, that money is taxed at ordinary income tax rates.
Congress has changed the rules on the deductibility of contributions repeatedly over the years, but assuming that the account owner is in a lower tax bracket as a retiree than as a wage earner, the tax treatment of the traditional IRA remains reasonably favorable.
Traditional IRAs are available to any taxpayer with earned income, but only those whose income is below certain thresholds can deduct the contributions if they -- or their spouses -- have a retirement plan at work.
The rules governing withdrawals are quite complex, however, and a mistake can have harsh consequences. Contributions must cease and withdrawals must begin soon after age 70 1/2, and withdrawals must be at least a certain minimum amount, based on the account owner's life expectancy, or that of the owner and beneficiary.
Under certain circumstances, both income and estate taxes can fall due at the death of an owner or beneficiary, producing effective rates that in a worst-case scenario can reach 90 percent.
Roth IRAs are quite different. Annual contributions, like those to a traditional IRA, are limited to $2,000 for a single person and $4,000 for a married couple, but with a Roth they are never tax-deductible. Instead, account earnings grow untaxed, and when withdrawn in retirement they are tax-free.
"It's like a toll road," said Arthur Auerbach, an accountant with offices in Vienna. With a traditional IRA you pay when you get off the road, and with a Roth you pay when you get on. "Therefore, the longer you are going to be on the road, the better the benefit of the Roth."
Also, there are no mandatory withdrawals with a Roth IRA, and holders can continue to contribute as long as they have earned income.
But not everyone can have a Roth IRA. Conversions are allowed only for taxpayers with incomes under $100,000 (the limit is the same for married and single people). Single taxpayers can make a full contribution to a Roth only if their income is less than $95,000, and married couples can make a full contribution only if their income is below $150,000.
The deadline for annual contributions, like that for traditional IRAs, remains the due date of your tax return -- April 15 for most people -- not including extensions.
The law creating Roth IRAs recognized that some people who already have traditional IRAs might prefer to have those funds in a Roth account. Therefore, taxpayers are permitted to convert a traditional IRA to a Roth. Such conversions are treated as distributions, however, meaning that you have to pay the income taxes. Otherwise, people who got a deduction before would be able to double-dip by getting tax-free withdrawals at the end.
On a big IRA, the taxes can be considerable, so for 1998 the law allowed taxpayers to spread the tax burden over four years. That is the special tax break that expired last week. Conversions continue to be allowed; it's just that henceforth the taxes will all have to be paid in the year of the conversion.
Choosing which IRA is better can be complicated, but experts note that the Roth has clear advantages for people in certain situations, among them:
Taxpayers who are over the limits for deducting contributions -- $50,000 for a full contribution for a married couple to a traditional IRA for 1998 if they have retirement plans at work -- but under the limits for a Roth. They won't get any front-end benefit but will get tax-free distributions and other benefits in retirement.
Young workers who are in low tax brackets but expect to have higher earnings later on. Any deduction they are allowed now is likely to be worth less than the tax exemption later on. Remember, a dollar deducted by someone in the 15 percent bracket saves only 15 cents in taxes.
Parents with teenagers who have part-time or summer jobs should give special consideration to opening a Roth IRA for the youngster. The account can be funded with a gift -- assuming the kid isn't ready to lock up his hard-earned cash for 40 years -- and over the decades turn into real money.
Older people who are unlikely to need their IRA money in retirement. Converting a traditional IRA to a Roth and naming a child or grandchild as beneficiary can be a very effective intergenerational transfer device. After account owners die, their beneficiaries can draw the money out over their lifetime, resulting in a long and large stream of tax-free income, assuming reasonable investment returns.
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