Geoff Wisner

The IRA Waxes Roth

By now you've probably heard about the Roth IRA, the new retirement account named after Senator Roth of Delaware. Pretty much all the financial magazines and business pages have taken a stab at explaining whether it's a good thing (most say yes) and under what circumstances you should consider starting one, or converting an existing IRA into a Roth.

The clearest explanation I've run across is by my favorite financial guru, Andrew Tobias, author of The Only Investment Guide You'll Ever Need. Tobias publishes a daily online column, in which he tells you about his car trips, plugs his new book (My Vast Fortune), answers readers' questions, and dispenses advice.

"The basic difference between the traditional IRA and the new Roth IRA is simple," says Tobias. "With the traditional IRA, you get a tax break for your contribution today, but pay taxes on everything you withdraw. With the Roth IRA, you get no tax break now, but so long as it's been in existence for at least 5 years, every penny you withdraw after age 59 1/2 (and even before 59 1/2 in limited circumstances, such as purchase of a first home) will be tax-free."

If you're covered by a 401(k) plan at work (like us), you can't contribute to a traditional IRA and get a tax deduction unless your adjusted gross income (as calculated on your income tax form) falls below certain limits. For the 1997 tax year your AGI must be less than $25,000 for a single person or $40,000 for a married couple filing jointly. For 1998 it's $30,000 for singles or $50,000 for married couples.

You can, however, contribute to a Roth IRA if you wish, up to the limit of $2,000 per year. (You can also contribute to a nondeductible traditional IRA, but since this would mean making contributions with after-tax dollars and then paying taxes again when you withdraw the money, why the *%@# would you?)

If you already have an IRA, you now have the option of converting it into a Roth IRA. As Tobias explains, this can be done without incurring the usual 10% penalty (on top of taxes) that you are usually hit with when you take money out of an IRA before age 59 1/2. "But you can only do it," he says, "if (a) your adjusted gross income is $100,000 or less" -- not a problem for most of us -- "and (b) you pay tax on the money you transfer. If you're switching $30,000 from a traditional IRA to a Roth IRA, and you're in the 35% tax bracket (federal and local), that would be $10,500 in tax. For transfers made in 1998 only, the IRS will allow you to pay the tax over four years.

"This would make sense," Tobias continues, "if you're in a low tax bracket now but you expect to be in a high one when you retire. You're young, living in a no-tax state now and are in the 15% tax bracket. You figure that by the time you retire, all states will have hefty income taxes and you'll have accumulated enough other investment income to throw you into a high federal tax bracket.

"On the other hand, if you're in a fairly high tax bracket now, it makes little sense to do so unless you expect your tax bracket to be high when you retire as well."

Personally, I would want to be pretty sure that I would get a substantial advantage from converting to the Roth before I went ahead. A tax break now is worth two in the future, and it's pretty hard to predict what the government's tax policies will be 30 or 40 years in the future. For all we know, the US may have broken up into warring fiefdoms, with only Kevin Costner and a sack of mail between us and total anarchy.

P.S. I had been thinking about writing an article about variable annuities and why they're such a lousy investment, and then I saw the cover story in the February 9 issue of Forbes, entitled "Don't Be a Sucker! Variable Annuities Are a Lousy Investment." This article covers the ground better than I could. Take a look at it if you're thinking about buying one of these expensive and inflexible white elephants.

Published in Bread and Cutter, March 1998.



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Geoff Wisner The IRA Waxes Roth By now you've probably heard about the Roth IRA, the new retirement account named after Senator Roth of Delaware. Pretty much all the financial magazines and business pages have taken a stab at explaining whether it's a good thing (most say yes) and under what circumstances you should consider starting one, or converting an existing IRA into a Roth. The clearest explanation I've run across is by my favorite financial guru, Andrew Tobias, author of The Only Investment Guide You'll Ever Need. Tobias publishes a daily online column, in which he tells you about his car trips, plugs his new book (My Vast Fortune), answers readers' questions, and dispenses advice. "The basic difference between the traditional IRA and the new Roth IRA is simple," says Tobias. "With the traditional IRA, you get a tax break for your contribution today, but pay taxes on everything you withdraw. With the Roth IRA, you get no tax break now, but so long as it's been in existence for at least 5 years, every penny you withdraw after age 59 1/2 (and even before 59 1/2 in limited circumstances, such as purchase of a first home) will be tax-free." If you're covered by a 401(k) plan at work (like us), you can't contribute to a traditional IRA and get a tax deduction unless your adjusted gross income (as calculated on your income tax form) falls below certain limits. For the 1997 tax year your AGI must be less than $25,000 for a single person or $40,000 for a married couple filing jointly. For 1998 it's $30,000 for singles or $50,000 for married couples. You can, however, contribute to a Roth IRA if you wish, up to the limit of $2,000 per year. (You can also contribute to a nondeductible traditional IRA, but since this would mean making contributions with after-tax dollars and then paying taxes again when you withdraw the money, why the %@# would you?) If you already have an IRA, you now have the option of converting it into a Roth IRA. As Tobias explains, this can be done without incurring the usual 10% penalty (on top of taxes) that you are usually hit with when you take money out of an IRA before age 59 1/2. "But you can only do it," he says, "if (a) your adjusted gross income is $100,000 or less" -- not a problem for most of us -- "and (b) you pay tax on the money you transfer. If you're switching $30,000 from a traditional IRA to a Roth IRA, and you're in the 35% tax bracket (federal and local), that would be $10,500 in tax. For transfers made in 1998 only, the IRS will allow you to pay the tax over four years. "This would make sense," Tobias continues, "if you're in a low tax bracket now but you expect to be in a high one when you retire. You're young, living in a no-tax state now and are in the 15% tax bracket. You figure that by the time you retire, all states will have hefty income taxes and you'll have accumulated enough other investment income to throw you into a high federal tax bracket. "On the other hand, if you're in a fairly high tax bracket now, it makes little sense to do so unless you expect your tax bracket to be high when you retire as well." Personally, I would want to be pretty sure that I would get a substantial advantage from converting to the Roth before I went ahead. A tax break now is worth two in the future, and it's pretty hard to predict what the government's tax policies will be 30 or 40 years in the future. For all we know, the US may have broken up into warring fiefdoms, with only Kevin Costner and a sack of mail between us and total anarchy. P.S. I had been thinking about writing an article about variable annuities and why they're such a lousy investment, and then I saw the cover story in the February 9 issue of Forbes, entitled "Don't Be a Sucker! Variable Annuities Are a Lousy Investment." This article covers the ground better than I could. Take a look at it if you're thinking about buying one of these expensive and inflexible white elephants. Published in Bread and Cutter*, March 1998.