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Questions, Answers About Roth IRAs

March 7, 1998

WASHINGTON (AP) _ The new Roth IRA promises the Holy Grail of retirement planning _ tax-free savings growth, with Uncle Sam unable to grab a penny when you withdraw money for retirement.

The Roth IRA also presents some tricky questions, especially for 4 million-plus Americans with existing IRAs who may want to convert to the new accounts.

Here are a few common questions and answers about the Roth IRA:

Q: What is a Roth IRA?

A: It’s a new retirement savings account created by last year’s tax bill. Named after Senate Finance Chairman William V. Roth Jr., R-Del., the Roth IRA is much different from the traditional IRA. People who qualify for the basic IRA can deduct their contributions. With the Roth IRA, you pay taxes when you contribute money, and you don’t get a deduction. The money grows tax-free, however, and you can withdraw funds without taxes after certain requirements are met.

Q: Does everyone qualify?

A: Singles making up to $95,000 qualify, and then benefits phase out at $110,000. Couples making up to $150,000 qualify, but it phases out at $160,000.

And there’s a different income limit of $100,000 for people who want to convert existing IRAs to a Roth IRAs.

``I think there is a lot of confusion,″ said John Gardner, senior manager for KPMG Peat Marwick in Washington. ``I’m surprised by the number of people (with incomes) over the income limitations″ who don’t know they can’t set up a Roth IRA, he said.

Q: How does it work?

A: You can contribute up to $2,000 a year into a Roth IRA. Funds can be withdrawn after age 59 1/2 or if the holder becomes disabled. The holder’s heirs also can withdraw tax-free funds after the holder’s death. Exceptions allow earnings and contributions for first-time home buyers.

Q: Why is this such a good deal?

A: Ann von Germeten, director of retirement services at Charles Schwab Corp., provided the following example: A couple making $40,000 invests $2,000 a year with an 8 percent return. After 20 years, earnings and contributions total $99,000.

A traditional IRA would earn $93,000 after taxes _ assuming money from the annual tax deduction was reinvested. If it wasn’t, the take would be $71,000.

With a Roth IRA, the entire $99,000 would go to the holder, without taxes.

Q: I already have a traditional IRA. Can I convert it into a Roth IRA?

A: If your income is less than $100,000, you can qualify for converting or ``rolling over″ your existing IRA into a Roth IRA.

In a rollover, income taxes are due on the amount put into the new Roth IRA, but there’s no 10 percent penalty for early withdrawal.

There’s also a one-time benefit this year for converting: Income tax payments can be spread over four years, instead of being due all in one year.

``If you run the numbers, most of the time it’s going to make more sense to convert,″ Gardner said. ``Especially if the money to pay the tax comes from outside the IRA.″ Many experts warn against using money from the IRA to pay taxes due on conversion, since it makes the transaction less economically attractive.

Q: Am I in trouble if I convert my traditional IRA into a Roth IRA, and I later discover my income unexpectedly rose over the $100,000 limit due to a big bonus?

A: The 1997 tax bill didn’t address this situation. So under current law, you could face taxes and penalties for taking an early distribution from a traditional IRA.

``If you get a bonus after that, you would be set up with an unqualified distribution,″ said Schwab’s von Germeten. That would result in taxes and penalties. Schwab is advising people who think they might be over the $100,000 rollover income limit to wait until the end of the year to see where their income ends up.

But there’s a pending bill to correct errors in the 1997 tax act which would address the issue.

``You essentially would roll it back to the traditional IRA that it came from,″ said IRS spokesman Don Roberts. ``The law, as passed, didn’t provide for it, but the technical corrections will.″

Q: I have a 401(k) plan at work. Should I quit it and start up a Roth IRA instead?

A: Another tricky question, but many experts say you should stay in a 401(k) plan and make maximum contributions, especially if the employer provides matching contributions.

Q: This sounds quite good. Will Congress change its mind and repeal the Roth IRA?

A: ``Based on the past experience with Congress on a tax benefit like this, they won’t do that,″ said Tom Ochsenschlager, a tax partner at Grant Thornton LLP in Washington. ``I don’t think Congress will pull the rug out.″

Congress has generally made such changes prospectively, not retroactively. And popularity of tax benefits such as the Roth IRA and the mortgage interest deduction is one main stumbling block for fundamental tax reform, he said. ``There are zillions of things like this that are problems,″ Ochsenschlager said.

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