A Woman and Her Money

Roth IRA: Is It for You?

Open a Roth IRA, and get tax-free money when you retire.

That sounds great to the millions of people being inundated with messages from their banks, brokers, mutual fund companies and insurance firms to invest in this latest twist on the ever-popular IRA. For many, it makes sense to open a Roth IRA this year, either with new cash, or by converting an old IRA to the Roth.

But the rules are complex and not yet definitive. Congress has a bill pending that may clear up the glitches that are inevitable in any tax legislation. And while it's hard to ignore the marketing pressure, there really is no reason to rush into a Roth until some of these issues are ironed out. You have all year to consider it.

Here are some questions and answers to help you figure out whether a Roth makes sense for you.

Q. What is this Roth IRA I keep hearing about?

A. The Roth IRA is another variation of the Individual Retirement Account but with a major benefit: Unlike the traditional IRA, you pay no taxes on the money you withdraw, provided you have had the account for at least five years and you are 59 1/2 or older. In contrast, if you withdraw money from a regular IRA after reaching age 59 1/2, the withdrawal is taxed at your current tax rate.

Q. Should I open a Roth IRA, which will give me my money tax-free when I retire, or a tax-deductible IRA so I can get the tax break now and have more money to invest? And what about the non-deductible IRA?

A. That depends on several factors. First, do you even qualify for a tax-deductible IRA? You do if you are single and your income is $30,000 to $40,000 or, if married, $40,000 to $50,000. But remember that you don't qualify if your employer has a pension plan. If married, your spouse might qualify if he or she is not covered by a pension plan at work.

As for the Roth IRA, a lot of sales literature will tell you that you're always better off with the Roth. But that really depends on whether you expect your tax bracket to be lower when you're ready to withdraw the money. If you think you will be in a lower bracket, it may pay to use the deductible account, provided that you qualify. If you think your tax rate will be higher, go for the Roth.

That leaves the taxable, non-deductible IRA, which makes no sense as long as the tax-free Roth is available. But if you're a married couple who earns more than $160,000 a year or a single person who earns more than $110,000 a year, the non-deductible IRA is one of your few options. Also, if you're a married couple filing separate returns, you're not eligible to open a Roth. Why? Ask Congress. We don't know.

Q. Can I put the money I have in a regular IRA into a Roth account?

A. Yes, you can convert an IRA to a Roth account if you qualify. But remember that the income limit to convert your IRA is much lower -- $100,000 no matter whether you're married or single.

Q. So I can just take the money out of my old IRA and convert it to a Roth?

A.Yes, but it will cost you. Congress considers the coversion from old IRA to Roth to be a taxable withdrawal. In addition, most companies will charge you to convert.

Q. Can you give me some more details on how this works? Are there any major downsides?

A. If you decide to convert, you get a break because you don't have to pay the 10 percent early withdrawal penalty even if you are under 59 1/2 just as long as the money goes right into the new account. Also, you don't have to count the money as part of your income for qualification purposes (unless you are a senior citizen who has to make a mandatory withdrawal from your old IRA; if so, see below).

The good news is that if you decide to convert, Congress will let you spread the tax bite over four years. For example, say you want to move $50,000 from your old IRA into a new Roth account. Over the next four years, you'll have to add $12,500 to your income, which you will be taxed on. And that could end up pushing your income into the next tax bracket.

Here's one potential downside. That extra income as a result of the conversion could push you over the income limit for education tax credits like the Hope Scholarship and the Lifetime Learning credit, as well as some student loan deductions.

Another thing to keep in mind is that the IRS will only let you spread out the tax bite from converting over four years as long as you convert by the end of this year. If you wait until 1999, you will have to pay taxes on the entire conversion, and that could really send you soaring into the next tax bracket. Of course, there is a possibility that Congress may change this when it votes on its upcoming tax bill. Or it may change it later.

Q. So is it better for me to leave my money in an old IRA or convert to a Roth IRA?

A. Conversion makes a lot of sense for many of you as long as you can afford to pay the taxes from other income. If you need to use money from your IRA conversion to cover the taxes, it counts the same as a withdrawal. And if you are under 59 1/2, that means you'll also pay a 10 percent penalty.

The general theory is that the younger you are, the better it is to convert because your money has a long time to grow tax-free, and many young people have the added benefit of being in a lower tax bracket. But the Roth also may make sense if you're older and are still working because unlike traditional IRAs, there is no age limit and there are no rules that require you to begin making withdrawals at 70 1/2.

If you are older, that means the Roth IRA can continue to grow tax-free, and you can take out only what you need to live, noted Gregory Kolojeski, president of BrentMark Software Inc., a tax software company in Winter Park, Fla. And when you die, you can pass the IRA along to your heirs tax-free.

Q. Can I open a Roth and put both the annual contribution and the conversion money in the same account?

A. You can, but you probably don't want to. It is better to open two accounts, one for the conversion and another for the annual contributions. That's because the distribution rules for the accounts are different and can be tricky. Two accounts simplify matters even if you have to pay fees to maintain both.

Q. Where does my 401(k) plan fit into this?

A. Go for the 401(k) first. You can put up to $10,000 a year in it, instead of the $2,000 IRA limit. Any money that you put in reduces your current income, so you pay less in taxes. If there is a company match, you are earning money instantly before you even make any investments. And, if you have any money left over, you can still open a Roth.

Q. If I open a Roth IRA, can I automatically take the money and the earnings out in five years tax-free?

A. That's the most common misconception about the Roth IRA. Remember, the R in IRA stands for retirement. You can withdraw your money -- contributions and earnings -- tax free after five years, provided you've reached age 59 1/2. Otherwise, you pay taxes, and penalties, just like any premature withdrawal from an IRA. But there are a few exceptions. Tax-free withdrawals on contributions can be made to pay for a first home (up to $10,000) or to pay for higher education (up to $10,000) also without the 10 percent penalty, although on education expenses, your earnings will be taxed.

Q. What about before five years? Is any of that tax-free?

A. Yes, the way the law is structured, you can take out your contributions to the Roth, (you've already paid taxes on them) but not the earnings, tax-free at any time. Still, it's important to remember that Congress could end up changing this law at any time, warns Ed Slott, a CPA in Rockville Centre, NY and publisher of "Ed Slott's IRA Advisor". Legislation that Congress is expected to pass this year is likely to make changes to the 1997 law that created the Roth IRA, Slott noted.

Q. There seems to be a lot of pressure to make a decision by April 15. Is that the actual deadline?

A. No, the deadline for opening a Roth and funding it is Dec. 31, 1998, and therein lies a problem. The $100,000 income limit is based on 1998 adjusted gross income, something most people don't know until 1999, especially people on commission or those who get bonuses or a raise.

Q. What happens if I find out in 1999 that my 1998 income was over the limit and I've already done a conversion?

A. Unfortunately, that's still unresolved. The legislation being considered by Congress would give you until April 15, 1999, to put the money back into a regular IRA without a penalty. It is also why many accountants suggest you wait until later in the year, when the legislation has been passed and the rules are more final.

Q. I know that my regular IRA is protected by state law from creditors. Does that mean the Roth is protected, too?

A. No, according to Garden City, NY tax lawyer Seymour Goldberg, author of "J.K. Lasser's How to Pay Less Money on Your Retirement Savings." State law now only covers IRA section 408 of the federal law, but the Roth IRA falls under Section 408A, Goldberg said. That means that it isn't covered until the state legislature amends the law to include it.

If you have credit problems, it may make more sense to wait to see whether the state law is changed. A conversion done before the law is changed would open the account to creditors.

Q. I know that the amount of money I convert from an old IRA to a Roth does not count as part of my adjusted gross income for qualfication purposes, but I am over 70 1/2 and have to take a minimum distribution from my old IRA as required by law. Does that count against my income if it puts me over the $100,000 limit?

A. The IRS says that it does count toward your qualifying income when you convert an old IRA to a Roth, which means that it can put you over the limit, precluding you from the conversion. Right now, the IRS is also saying that if you don't take the distribution to avoid going over the limit, preferring to pay the 50 percent surcharge for not withdrawing the money, it will still count toward total income. The technical corrections bill may change that, but don't count on it.

Q. How do I know that in 20 or 25 years, before I take my tax-free money out, Congress won't change the law and decide to tax it?

A. You don't, although most experts said that all that Congress is likely to do is end the program and grandfather those accounts already set up. It would depend on how badly Congress decided it needed the money at that time. Our legislators just might slap a surcharge -- a tax -- on the money instead of an income tax. Hey, we don't know what they are going to do on the technical corrections bill this year. Twenty years is an eternity in taxland.

A Woman and Her Money is a regular feature at The Working Moms' Internet Refuge

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