Beginning in 1998, taxpayers have a new, tax-favored retirement accumulation vehicle in the Roth IRA. Similar in concept to the traditional IRA, the Roth IRA differs in that contributions are never deductible, and, if certain requirements are met, distributions from the account may be received free of federal income tax.

Annual Contributions: A Roth IRA may be established and funded at any time between January 1 of the current year, up to and including the date an individual's federal income tax return is due, (generally April 15 of the following year), not including extensions. The account must be designated as a Roth IRA at the time it is established.

Conversion of Existing IRA Accounts: IRC Sec. 408A which provides for Roth IRAs, allows an existing, traditional IRA (either an annual contribution IRA or a "rollover" IRA) to be converted to a Roth IRA. The taxpayer making the conversion mast have an adjusted gross income (AGI) of $100,000 or less in the year of conversion or no conversion is permitted. If a taxpayer converts amounts to a Roth IRA and then discovers, after the close of the tax year, that AGI exceeds $100,000, a trustee-to-trustee transfer of the converted amounts to a traditional IRA can be used to correct the "erroneous conversion." The law also prohibits conversion if the taxpayer is using the married filing separate status.

The conversion from the "old," traditional IRA to the Roth IRA results in a taxable event; IRA contributions previously deducted, and all earnings, are added to the taxpayer's gross income in the year of conversion. While a taxpayer may reverse a conversion to a Roth IRA, there are limits on the number of conversions and "unconversions." A taxpayer may convert to a Roth IRA only two times during a tax year. For example, assume that a taxpayer converts and then unconverts a Roth IRA in tax year 1999. The taxpayer may make only one more conversion to a Roth IRA during 1999.

Any 10% excise tax penalty for withdrawals before age 59½ which might apply to converted amounts is waived. However, if a taxpayer withdraws amounts from the converted Roth IRA within five years or the year of conversion, the 10% excise tax will apply.

Type Of Arrangements Permitted

There are currently two types of Roth IRAs:

1. Individual Retirement Accounts: A trust with a corporate trustee
2. Individual Retirement Annuities: A special annuity issued by a life insurance company

Contribution Limits

Limits: A wage earner may contribute (but not deduct) the lesser of $27000 or 100% of compensation earned for the year. If the wage earner is married, an additional $2,000 may be contributed on behalf of a lesser earning (or non-working) spouse, using a "spousal" account. A husband and wife may contribute up to a total of $4,000, as long as their combined compensation is at least that amount.

Contribution Phase-out: The maximum contribution to a Roth IRA is phased out for single taxpayers with adjusted gross income between $95,000 and $110,000. For married couples filing jointly, the phase-out range is an AGI of $150,000 to $160,000. For married individuals filing separately, the phase-out range is an AGI of $0 to $10,000.

Other IRAs: The contribution limits for a Roth IRA are coordinated with those of the traditional IRA; a taxpayer may not contribute more than $2,000 ($4,000 for a married couple) per year into a single IRA or a combination of traditional and Roth IRAs. Excess contributions to a Roth IRA are subject to a 6% excise tax, for each year that any excess remains in the account.

Taxation Of Distributions

Distributions from a Roth IRA which are "qualified distributions" are not subject to federal income tax. Qualified distributions are distributions which are made after a five-year waiting period, and which are made:

1.  After the taxpayer reaches age 59½; or

2.  In the event of taxpayer's death; or

3.  Because the taxpayer becomes disabled; or

4.  To pay for "qualified first-time home buyer" expenses.

Distributions that are not "qualified" distributions are subject to tax. Amounts withdrawn are first considered to come from nondeductible contributions (all Roth IRAs are aggregated for this calculation), and are not subject to tax. After all original contributions have been withdrawn, remaining amounts are considered to be income earned within the IRA and, if withdrawn, are taxable. If taxable distributions are received prior to age 59½, a 10% penalty tax may be added.'

A taxpayer who converted a traditional IRA to a Roth IRA in 1998 could have elected to recognize any taxable income from the conversion ratably, over a four-year period. If such a taxpayer withdraws amounts from the Roth IRA prior to the year 2001, however, the benefits of any remaining deferral will be lost and recognition of any remaining unrecognized income will be accelerated, up to the amount of the distribution allocable to the 1998 conversion.

Other Differences

There are several other significant differences between the traditional IRA and the Roth IRA.

Contributions After Age 70%: Unlike the traditional IRA, contributions to a Roth IRA may be made even after the taxpayer has reached age 70 1/2, as long as the taxpayer has compensation.

Distribution Requirements: Roth IRAs are not subject to the mandatory distribution requirements during the life of the owner (triggered at age 70 1/2), which apply to traditional IRAs.

Incidental Death Benefit: Roth IRAs are also not subject to the incidental death benefit rules of IRC Sec. 401(a), which govern the timing of death benefit distribution, as are traditional IRAs.

The dollar amount in an existing IRA is relatively small.

The majority of contributions In an existing IRA consists of
nondeductible contributions.  A taxpayer has at least 5 years before withdrawals are planned.

A taxpayer anticipates that the funds in an IRA will not be needed at retirement and would like to continue tax free growth for as long as possible.

Sufficient non-IRA funds are available to pay the additional income tax due as a result of the conversion from a traditional IRA to a Roth IRA.

It is anticipated that a taxpayer's marginal tax bracket during retirement will be the same as, or higher than, the current marginal bracket.

Investment Alternatives

Banks and Savings and Loans: Certificates of deposit are generally insured by the FDIC. Fixed and variable rates are available. There may be stiff penalties for early withdrawal.
Annuities: Traditional, fixed individual retirement annuities issued by life insurance companies can guarantee fixed monthly income at retirement and may include a "disability waiver of premium provision. Variable annuities do not guarantee a fixed monthly income at retirement.
Money Market: Yield fluctuates with the economy. Investor cannot lock in higher interest rates. It is easy to switch to other investments.
Mutual Funds: A wide variety of mutual funds with many investment objectives are available.
Zero Coupon Bonds: Bonds are issued at a deep discount from face value. There are no worries about reinvesting interest payments. Zero coupon bonds are subject to inflation risk and interest rate risk.

Stocks: A wide variety of investments (and risk) is possible. Losses are not deductible.

Limited Partnerships: Some limited partnerships are especially designed for qualified plans, specifically in the areas of real estate and mortgage pools.

Prohibited Investments Or Transactions

Life Insurance: Roth IRAs cannot include life insurance contracts.

Loans to IRA Taxpayer: Self-borrowing triggers a constructive distribution of the entire amount in an IRA.

Collectibles: Purchase of art works, antiques, metals, gems, stamps, etc., will be treated as a taxable distribution. Coins issued under state law and certain U.S. gold, silver, and platinum coins are exceptions. Certain kinds of bullion may be purchased.

Is the interest rate fixed or variable? If interest rates drop, a fixed rate is better, especially if you can make future contributions at the same fixed rate. If interest rates go up, you may be able to roll the account to another Roth IRA.

What is the yield? More frequent compounding will produce a higher return.

Is there a return on my investment?