By JANE BRYANT QUINN
It’s the Year of the Roth the new Roth Individual Retirement Account.
You’re seeing the ads everywhere, at banks, insurance companies, mutual funds and brokerage firms.
They all make a Roth investment sound like the greatest thing since Post-it Notes. For some people, that’s true, but not for everyone. In many cases, it’s smarter to put your money into a more traditional retirement account.
IRAs are for workers who can save up to $2,000 a year ($4,000 for married couples). And without doubt, the Roth is an interesting buy. There’s no tax deduction for the money you put in. But the earnings you build can be withdrawn entirely tax free, as long as you follow the rules.
You qualify for a full Roth contribution as long as your adjusted gross income doesn’t exceed $95,000 if single or $150,000 for married couples. Above that, the size of your contribution phases out. The Roth rules, in a nutshell:
– You can keep on contributing as long as you work. Contributions can be withdrawn tax free anytime you want.
– After holding the Roth for five years, you can also withdraw your earnings tax free if you’re at least 59 and a half years old, or disabled, or need up to $10,000 to buy a first home.
– You can leave your money in the Roth as long as you want. There are no mandatory withdrawals. If you die, your heirs will get your Roth income-tax free, as long as you held it at least five years. (Estate taxes are due, however, if you’re wealthy enough.)
The value of this investment almost jumps off the page. For example, say you’re in your 20s and saving for a home. The Roth makes your savings account tax free. If you can’t afford $2,000 (or $4,000) a year, maybe your parents can put up the money for you.
And say your teenager has a job and is spending the money (or maybe saving it for college). No problem. You can still fund that child’s Roth, with a sum equal to his or her earnings, up to $2,000. That’s a bonanza, if left to grow.
Roths are also terrific for heirs. The money can accumulate over your lifetime; then pass to your spouse tax free and continue to accumulate; then pass to a child or another beneficiary payable over the recipient’s lifetime.
But what if you expect to draw out most of that money as you age? Here’s where other retirement plans might come out on top. There are several alternatives 401(k)s and 403(b)s for employees; plans designed for the self-employed; and traditional IRAs. All of them let you tax-deduct your contribution and accumulate earnings tax-deferred. You pay income taxes on the money you take out.
It would be nice to have a fully funded retirement plan, plus a Roth on the side. But here’s how to choose if you can’t afford both:
(1) An employee plan is always a winner if it matches the money you put in.
(2) Employee plans are also better if you might suddenly need cash. Most 401(k)s will give you a loan, which lets you put the money back. With Roths, you can take out the money you contributed, but it can’t go back into the plan if you keep it more than 60 days.
(3) What if your company doesn’t match your contributions? What if you’re self-employed? In these cases, which plan to choose will depend on your current tax bracket vs. the bracket you think you’ll be in when you retire, says Greg Jenner of consulting firm Coopers & Lybrand.
A traditional, tax-deductible plan is better for workers whose tax brackets are currently high but will probably fall to 15 percent. You’d avoid a high tax when your money went into the plan and pay a low tax when it came out.
But a Roth accumulates more money for people whose tax brackets will rise, stay the same or fall just a little bit.
You don’t know what your future tax rates are going to be, of course. The Roth locks in today’s rate, which may be fine with you.
Hot air alert: I’ve looked at a lot of sales literature for Roths. The brochures that compare them with traditional IRAs (and, by extension, any tax-deductible account) invariably show the Roth as the star.
You have to go to the footnotes to learn that the seller assumed that your tax bracket won’t decline. If that’s not true in your case, send the salesperson back to the drawing board.
Should I convert?
I’ve been flooded with letters from people asking whether to convert their savings from regular Individual Retirement Accounts to a Roth. Unfortunately, there’s no single answer. Some people should convert, others shouldn’t. But there are some general rules of thumb.
You qualify for a conversion of a current IRA to a Roth if your adjusted gross income is $100,000 or less, married or single. But the rollover isn’t tax free. The money you convert has to be reported as taxable income. (Your taxable IRA income, by the way, doesn’t count toward the $100,000 limit.)
If you switch to a Roth in 1998, you can spread the income, and thus the tax, over the next four years. If you wait until 1999 or later, your tax will be due all at once.
Should you convert? Here are the general rules:
– Don’t convert if you’ll have to pay the income tax out of your IRA funds. It’s unlikely that you will recover that loss.
– Do consider converting if you can pay the income taxes out of your earnings or other savings. The tax-free growth might yield more in the end.
– Don’t convert if you will drop to a much lower bracket in retirement. This rule would cover someone in the 28 percent bracket who expects to retire in the 15 percent bracket. It’s better to wait and pay the tax when your bracket is low.
– But do consider converting if your tax bracket will rise in retirement, remain the same or fall just a little bit. For example, a conversion might be smart if your bracket goes from 31 percent down to 28 percent and you hold at least seven or eight years, according to The Vanguard Group of mutual funds.
– Do convert if you won’t need this money in old age, or won’t need much of it. You don’t have to start taking out the money at age 70 1/2, as you would with a regular IRA. Your Roth can be left to your heirs, income-tax free.
Syndicated columnist Jane Bryant Quinn can be reached in care of the Washington Post Writers Group, 1150 15th St., Washington D.C. 20071-9200.
