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IRAs: Roth redux in 1999
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March 20, 1999: 9:09 a.m. ET
Missed out in '98? Here are ways to minimize pain of converting in '99
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NEW YORK (CNNfn) - To Roth or not to Roth, unfortunately, is still the question.
If you didn't convert your traditional Individual Retirement Account to a Roth IRA last year, don't think you're off the hook. While you no longer can spread the income tax due on the converted amount over four years, as you could if you converted last year, Roth IRAs still may be right for you.
"It's the best motivation to save for retirement that we've seen in America," said Ed Slott, a CPA and editor of an IRA newsletter. "Everybody should be in the Roth game if they can."
The basic difference is that in a traditional IRA, contributions may be deductible but taxes are owed on withdrawals; in a Roth IRA contributions aren't deductible but the money grows tax-free. Also, investors must start withdrawing money from traditional IRAs at age 70-1/2 but not from Roth IRAs, so those lucky enough to do so can leave the funds untouched for heirs.
Roth wanted to boost savings
Senate Finance Committee Chairman William Roth, whose legislation created the IRA bearing his name, wanted to encourage Americans to save. Nearly half of Americans say they have less than $10,000 saved and just 30 percent of those nearing retirement have that much socked away, he says.
The most critical things to weigh when deciding whether to convert to a Roth account are your age, what you plan to do with the money in your IRA, your expected tax bracket at retirement and the tax bill for the conversion. While the decision is not an easy one, and converting may result in a big short-term tax bill, it could prove lucrative in the long run.
For example, assume you are 36 and single with taxable income of $60,000. If you convert an existing IRA with $75,000 to a Roth IRA, you'll owe about $17,000 in taxes for the conversion. Assume further that the converted money earns a 10 percent annual return in a stock fund, and your Roth IRA will be worth $1,916,075 when you're 70, compared with $1,645,039 for a traditional IRA. This example was figured using a so-called lump-sum Roth IRA calculator. Many calculators are available to help you decide. (Click here for info on calculators).
Here are some tips if you decide to convert.
Switch a quarter of your traditional IRA each year for the next four years, which will allow you to get the four-year payout on the taxes due that you missed last year. If you're in the 28 percent tax bracket and have a $50,000 account, you'd owe the federal government about $3,500 a year to convert the funds over four years. State taxes may make that higher.
"That seems to be the prevailing strategy for someone who missed the opportunity in 1998," said Jan Holman, financial services expert at American Express Financial Advisors.
Have cash on hand to pay the taxes
Make sure you have the cash to pay any taxes owed. "You've got to come up with the cash in one year," said Laurence Foster, a partner at KPMG, the accounting and consulting firm, noting it doesn't make sense to pay the tax bill with funds from the IRA.
Look for deductions to help offset taxes owed from a full or partial Roth conversion. This could mean taking a loss on a stock sale or other investment, or looking for more nonreimbursed business expenses, for example.
"You certainly have plenty of time to do it," said Slott, whose Web site can answer questions on Roth or traditional IRAs.
If you own your business, pay bills that are deductible expenses early and take any losses that you can in a bid to push a deductible loss onto your personal tax return.
Getting married late in the year? Pushing the wedding back to early 2000 may pay. The limit for single or joint filers when it comes to converting is $100,000 in adjusted gross income, so marrieds are in effect penalized.
"If you've planned a late wedding it may pay to put it off a few days into 2000 because the savings over (both) your lifetimes may pay for a few weddings for the kids," Slott said, noting the delay would allow you to convert in 1999.
Try a bottom up approach
Another approach is from the "bottom up," or figuring how much you can afford to pay in taxes -- $1,000, $3,000 or more, for example -- and then converting $3,570 or $10,700 or more, assuming a 28 percent federal tax rate.
If your earnings fluctuate and are fairly predictable, plan to convert in a year when you'll have less income, which could pull your bracket down, thus lowering the tax bill on the converted dollars. This may work if you're nearing retirement, some experts said.
But that raises the question of whether it pays to convert at all if you're older.
"If there's one generalization you can make, it's that Roth IRAs are for younger people, but that may extend up as high as 50, depending on the circumstances," Slott said.
As a rule of thumb, the money should be able to sit in a Roth account at least 10 years to make a conversion pay, said Ellen Breslow, senior vice president and director of retirement planning at Salomon Smith Barney.
If converting doesn't work for you, starting a Roth may make sense. Don't fret losing a $2,000 deduction to a traditional IRA, experts said, since most people never reinvest the money they save in taxes. The additional $600 or $700 in tax refunds "most people blow on pizzas," Slott said.
Age critical in making Roth decision
If you're 55 and may need the funds from a Roth in five years or so, it may not be worth converting. Keeping money in an IRA longer gives it more time to grow and more chances to avoid short-term dips in stocks, which outperform all other investments in the long run.
The main thing is to do your homework, formulate a plan and stick to it, experts said.
"It's like losing weight," said American Express' Holman. "It's about behavior. In weight loss, it's eating less and exercising. In investing, it's taking advantage of opportunities to invest dollars that are saved from taxes."
-- by staff writer Steven Radwell 
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