IRAÉConversion depends on time until retirement

by Alvin W. Weiss

for the Business Journal

The Taxpayer Relief Act of 1997 has awakened interest in IRAs as a means of saving, not only for retirement, but also for other long-term goals such as first-time home ownership and a college education.

The Roth IRA is a "back-loaded" IRA, which means that contributions are nondeductible, but distributions, if specific requirements are met, would be tax-free, and/or penalty free.

Contributions to a Roth IRA depend on your adjusted gross income (AGI). Contributions are phased out for singles whose AGI is between $95,000 and $110,000, and for married couples whose AGI is between $150,000 and $160,000.

Funds in your Roth IRA grow tax-deferred until they are withdrawn. The tax and penalty status of the funds depends on how long ago you made the first contribution to your Roth IRA, your age and what these funds will be used for. If you withdraw the funds after age 59 1/2 and the first contribution was made five years ago, then the withdrawal is tax- and penalty-free under all circumstances.

If the funds in a Roth IRA are used for the purchase of a first home, all withdrawals up to $10,000 are tax- and penalty-free, as long as they were held in the Roth IRA for at least five years from the date of the first contribution.

By contrast, funds used for college expenses for yourself or your immediate family will be penalty-free, but will be subject to ordinary income taxes on the accumulated earnings.

Finally, if funds are withdrawn before five years from the date of the first contribution, the earnings on these funds are subject to regular income taxes and will be assessed the 10 percent penalty for early withdrawals. The maximum annual contribution to a Roth IRA is $2,000 or 100 percent of earned income, whichever is less.

To convert or not to convert?

The Roth IRA poses an interesting question: If you own a traditional IRA and your AGI is $100,000 or less, should you convert these funds to a Roth IRA? The longer your investment horizon, the more attractive this option may be. You will gain the benefit of tax-free withdrawals in the future; however, current taxes, but no penalty, will have to be paid at the time of the conversion.

If the conversion occurs in 1998, the taxes will be spread over a four-year period. Transfers made after 1998 will be subject to taxes in the year the transfer is made.

If you fit any of the following profiles, a traditional-to-Roth IRA conversion might be worth considering:

?Your traditional account has been opened for a short period of time and most of the balance comprises nondeductible contributions.

Since there is little growth in your current IRA and since no taxes are owed on nondeductible IRA contributions, your tax liability will be low at conversion because taxes are only paid on the growth of the funds and on the deductible contributions.

?You do not need your existing IRA funds for support during retirement.

You will have a longer time to recover the taxes paid at the time of conversion if you don't take distributions out of your Roth IRA.

Also, minimum distributions are not required in a Roth IRA at age 70 1/2 and, in fact, if you have earned income, you can continue funding a Roth IRA after age 70 1/2. Your Roth IRA has more time to grow tax-deferred and funds can be passed on to heirs tax-free.

?You are many years from retirement.

The longer you are away from retirement, the more time your Roth IRA will have to recover from the taxes paid at conversion and the longer the account will benefit from years of tax-free growth.

?You anticipate your tax bracket will remain the same or will be higher during retirement.

You will pay taxes at a lower or at the same rate at the time of conversion than you would if you took money out of the existing IRA after retirement. Also, any growth in the account after the conversion will be tax-free after five years and at age 59 1/2.

On the other hand, if you fit any of the following profiles, you would probably not benefit from a traditional-to-Roth IRA conversion:

?You are near to retirement and will have to make withdrawals from your existing IRA upon retirement.

A conversion would decrease funds available during your retirement, and you would probably not have time to recover the taxes paid at the time of conversion.

?You expect to be in a lower tax bracket at retirement.

There is no reason to pay taxes on the conversion at a higher rate than you would at retirement.

These are just some guidelines to help determine if you should convert your existing IRA to a Roth IRA.

In order to find out if a Roth IRA makes sense for you, you should contact your tax or financial adviser and request a comparison between a Roth and a traditional IRA, and the effects of a conversion using your specific IRA balance and tax situation.

Note that individual state taxation on traditional-to-Roth IRA conversions has yet to be determined.

(Alvin W. Weiss is a financial consultant with SmithBarney in Springfield.)

INSET CAPTION:

The maximum annual contribution to a

Roth IRA is $2,000

or 100 percent of earned income, whichever is less.[[In-content Ad]]