The new Roth IRA may be one of the most complicated features of the new tax code, but its super benefits have many Americans slapping their faces in disbelief.
Named after Senate Finance Chairman William V. Roth Jr. (R-Del.), the Roth IRA was unveiled last July. The IRS admitted at the time that consumers were getting “the most complex tax law we’ve seen in 10 years.” Today, as the April 15 tax-filing deadline nears, banks, brokerages and many journalists are still trying to explain the differences between the Roth IRA and the regular IRA in simple English.
But to investors who have already grabbed onto the Roth retirement product, the feeling has been one of “disbelief,” says Sidney Norton, a tax adviser based in Redding, Calif. “They can’t believe this (the Roth IRA) is really happening, that something as good as this can last forever. They’re afraid someone is going to come along and take it away.”
If you’re not yet up on all the IRA changes, start with this basic picture:
Beginning with your tax contributions for the 1998 tax year, you have three IRA choices:
– Contributing to a new Roth IRA. Your savings will grow tax-free and you won’t be taxed one dime when you eventually withdraw money for retirement.
– Open or continue contributing to a regular IRA, as you and 4 million other investors have been doing.
– Or contribute to both types of IRAs, provided your total annual contributions aren’t more than $2,000.
One big difference between the new Roth IRA and the old-fashioned IRA: when and how you’re taxed. With the Roth version, you pay taxes on your contribution and don’t get a deduction. But there’s the big tax-free advantage after that, if the account has been open and funded for at least five years. With a conventional IRA, withdrawals are taxable when you retire.
Here’s what that can translate into, in plain dollars and cents:
Suppose you invest $2,000 a year, and your money earns 8 percent annually over the next 20 years. Assume that you then take the money in one lump sum. You would have $98,846 in a Roth IRA compared with just $84,019 in a traditional IRA.
And here comes the first big clue on which type of IRA is best for you. Unless you need a big tax break, the Roth version would probably make more sense than the plain-vanilla variety. Indeed, says Bernard Sonnenfeld, a tax adviser in North Palm Beach, Fla., “the Roth IRA may not be for younger people who need a tax deduction to make ends meet.”
Your age and income also play a part in your decision. For the regular IRA, anyone under age 70 1/2 with earned income is eligible, regardless of how much they make. A non-working spouse can also contribute up to $2,000 per year. But–and here’s where it gets tricky–with a Roth IRA individuals of any age are eligible with an earned income of less than $95,000 for single people, or $150,000 for joint tax returns. If you earn more than that, sorry, you can’t contribute. That’s something a lot of well-heeled folks aren’t aware of, according to tax experts.
More comparisons between the two types of IRAs:
– When you open a Roth IRA, there’s no age limit for your additional contributions, while the standard IRA requires that you must be younger than 70 1/2.
– With a regular IRA you can transfer money to and from other IRAs, and also roll over funds from employer plans. Not necessarily so with the Roth. You may transfer a traditional IRA to a Roth IRA only if your adjusted gross income is less than $100,000.
– And if you convert a regular IRA to a Roth IRA, you must pay taxes on all deductible contributions and earnings. The bad news is that you must fund those taxes from outside your IRA money. The good news is that you won’t have to pay the usual 10 percent tax penalty on early withdrawals.
Not all of the new tax code is yet carved in stone. There’ll be “technical corrections” made by Congress, and IRS interpretations, as questions and issues arise, say observers.
The bottom line is that the Roth IRA gives you a new whack, and more clout, at putting aside more tax-free money for your retirement, so you’d be wise to seek the help of a savvy tax counselor now. Granted, the subject is as dry as a bone, but the extra bucks will count when you’re one day rocking on the porch, checking out a sunset.
Besides deciding which IRA is better for you, you also need to figure what percentage of your money will go into stocks, bonds, mutual funds or bank CD IRAs. That means examining your IRA investments as part of your overall portfolio.
– Credit tip. If you use your credit card to make purchases in a foreign country, the charge is converted into a U.S. dollar amount at the time it is received by the bank in the U.S. Exchange rates fluctuate daily.
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Robert Heady publishes Bank Rate Monitor, a newsletter based in North Palm Beach, Fla. If you have questions or comments, write to him in care of this newspaper or send e-mail to jrnl8888@aol.com.
