IRAs for Everyone!

By Philip J. Beavers, CFP,
WEAC's Member Benefits Specialist

November 1997

Financial Planning Seminars
Achieving Financial Independence

Law creates new options for IRA investments

The 1997 tax act significantly expanded the opportunity for members to use Individual Retirement Accounts (IRAs). The act not only increased access to the traditional IRA for many members, it also created a new, non-deductible, tax-free IRA (Roth IRA) and an educational IRA.

The formal name of the act is the Taxpayers Relief Act of 1997. It might be more aptly named the Tax Complexity Act of 1997. The following is an attempt to sort out the complexity involved in the expanded IRA options.

Changes to the traditional IRA

Many members and spouses will find that they can begin using deductible IRAs in 1998 for the first time since 1986. For 1998, the income caps for which deductions begin to phase out will rise to $50,000 on a joint return (currently $40,000) and to $30,000 (currently $25,000) on a single return. The income lid climbs gradually over the next 10 years.

In addition, the new law removes the restrictions that prevent spouses of members from contributing to a deductible IRA. If the joint income is below $150,000, the spouse who is not eligible for an employer plan will now be able to deduct up to $2,000 in a regular IRA, even if his or her spouse has an employer plan.

The act also provides new exceptions to the 10% additional tax on early withdrawals from IRAs. The new exceptions are for withdrawals to pay qualified higher education expenses and for qualified, first-time home buyers.

Non-deductible educational IRA

An educational IRA is a trust or custodial account that exists as a separate IRA account established for paying qualified higher educational expenses. Up to $500 per child, per year, can be contributed until the child is 18. All earnings grow tax-deferred, and withdrawals for post-secondary educational expenses are tax-free. Only withdrawals that exceed qualified higher educational expenses are subject to income taxes and the additional 10% tax. The full benefit is limited to joint filers with income below $150,000 and single parents with income below $95,000.

Roth IRA

Perhaps the most significant IRA change is the addition of the Roth IRA, named after Senator William Roth, of Delaware, the Finance Committee Chairman. Roth IRAs lack the pre-tax deposit advantage of a regular IRA (up-front tax deduction); however, they offer an opportunity for tax-free income in retirement. The money will grow tax-deferred and can be withdrawn tax-free after age 59?, providing the account is at least 5 years old. Non-taxable, qualified distributions from a Roth IRA are distributions made at least five years after the first taxable year in which the individual made a contribution to the Roth IRA, if they are made:

1. After the individual reached age 59?,
2. After death,
3. On account of disability, or
4. For qualified, first-time home purchase.

After January 1, 1998, individuals making less than $95,000 per year may put as much as $2,000 annually into a Roth IRA. Couples may contribute up to $4,000 if they earn less than $150,000 jointly per year. Contributing money to a Roth IRA will not affect the maximum annual contribution that a member can make to his/her tax-sheltered annuity (403-b plan).

Principal features of a Roth IRA include:

1. No tax deduction is allowed for contributions.
2. Income accumulation is tax- free.
3. Qualified distributions are not subject to income taxes.
4. Income limitations for contributions begin at:
   • $150,000 for married taxpayers filing jointly,
   • $95,000 for single taxpayers, and
   • married persons filing separately cannot contribute to a Roth IRA
5. No distributions required when the individual attains age 70?.
6. Distributions are only required upon death.
7. Rollovers are permitted from one Roth IRA to another Roth IRA.

It is possible that a Roth IRA may be more advantageous than a tax-sheltered annuity (403-b plan) for those who cannot afford both. With a good retirement plan and a large 403-b account, many members will remain in the same tax bracket in retirement, as when they were working, making the Roth IRA more appealing. Members who expect to be in a lower tax bracket when they will be making withdrawals may do better with a tax-sheltered annuity.

The law allows taxpayers with adjusted gross incomes of less than $100,000 to convert existing deductible IRAs into Roth IRAs. Income taxes must be paid on the conversion. If converted in 1998, the law allows the tax payments to be spread over four years. The longer a person has until projected withdrawal, the more financial sense it makes to convert to a Roth IRA.T. Rowe-Price advisors suggest that, “anyone who is 15 years away from taking withdrawal is going to be better off converting to a Roth IRA.” Keep in mind that you do not want to take the tax payment on a conversion out of your IRA monies. You need sufficient other monies to pay the tax.

Posted October 27, 1997