Iras Not What They Used To Be New Rules Offer More People A Chance To Save, Buy A Home Or Pay For College

Whether they’re saving to buy a home, pay for college, retire in style or leave money to their grandchildren, Americans are about to get some powerful help: Individual Retirement Accounts have been reinvented.

Starting Jan. 1, people will be able to choose from two new kinds of IRAs and an updated version of the regular IRA. Millions more people will be eligible to open the tax-sheltered accounts. And IRAs will have more uses: Besides providing income in retirement, they can help with buying a first home or paying for college.

One new account - the Roth IRA - already is being praised as revolutionary because of its flexibility and its tax-free investment earnings.

The other new account, the education IRA, will provide modest help to pay for college. And traditional IRAs will be available to more people and allow more uses.

The IRA changes are part of the tax cut Congress approved last summer. Investment companies and banks have started massive advertising campaigns to alert people to the options.

But with choice comes complexity. “IRAs are no longer simple,” said Paul Yakoboski, a retirement expert at the Employee Benefit Research Institute in Washington.

For people interested in the new IRAs, here are some answers to common questions asked of financial planners:

Q: I have an IRA from the 1980s, but I stopped contributing because my income was too high to get the tax deduction. Will things change for me?

A: Yes. Most Americans will be eligible to lower their taxes by saving money in an IRA.

For people covered by a retirement plan at work, income limits for making tax-deductible contributions to a regular IRA will rise to $30,000 for singles and $50,000 for married couples. For the first time, stay-at-home spouses will be able to contribute the same amount as a worker - $2,000 a year.

For the new Roth and education IRAs, income limits are even higher - $95,000 for single people and $150,000 for married couples.

That means that about 90 percent of American households will be eligible for a tax benefit from IRAs. Currently, about half of households are eligible to make tax-deductible contributions to a regular IRA.

Q: Who is this Roth?

A: Sen. William Roth, R-Del., chairman of the tax-writing Senate Finance Committee, is a longtime IRA enthusiast and tax-cut advocate.

His IRA has inspired a Roth Website on the Internet (www.rothira.com) and even new vocabulary words, as people wonder whether to “rothify,” or convert regular IRAs into “Roths.”

Q: What makes his IRA so special?

A: The Roth IRA can bring greater flexibility to family financial planning, and offers the potential to build more tax-free wealth than regular IRAs, financial planners say.

As with a regular IRA, individuals may put up to $2,000 a year in a Roth IRA, or $4,000 per couple. After that, the rules change.

Money deposited in a Roth IRA is not tax-deductible. But the investment earnings can be withdrawn tax-free, as long as the account is open for at least five years and either of two conditions is met:

The account holder is at least 59-1/2.

The money is being used to buy a first home.

With a regular IRA, taxes are deferred into the future. People must pay taxes when they withdraw investment income in retirement.

For many savers, the benefit of tax-free build-up in a Roth IRA will make them richer over time than the tax deferral they would get with a regular IRA. This is especially true for younger people and for people who expect their tax rate to stay about the same after they retire.

“Roth IRAs are going to be particularly beneficial for people in their 20s,” said Paula Hogan, a financial planner in Milwaukee. “If they can max out on their contributions and then simply leave it alone, they could end up with a couple of million dollars.”

People may put money in both types of IRAs, but the total contribution each year cannot exceed $2,000 per individual and $4,000 per couple.

Roth IRAs have other attractive features: T

he principal can be withdrawn at any age and for any reason, without paying tax or penalties.

They can be used to pay for college. Although no early withdrawal penalty applies, income taxes must be paid on investment earnings taken out to pay for education.

Unlike a regular IRA, no mandatory withdrawals are required after retirement, and contributions may be made at any age.

Heirs to the account don’t have to pay income taxes on the money, though it does count for estate-tax purposes.

Q: Can people change regular IRAs into Roths?

A. Yes, if income is less than $100,000. But experts recommend careful study. Income taxes are due when a regular IRA is closed, and because of that some people might only break even, or risk losing money in a conversion.

“You can’t go around saying everybody should convert to a Roth IRA,” said Debra Dyer, a tax expert with the accounting firm of Deloitte & Touche. “You’re going to have to make some assumptions when you do it, and those assumptions may not come true.”

People who make the change during 1998 will get special consideration. They’ll be allowed to spread taxes owed on their regular IRA over four years.

Experts say a key factor is whether people can afford to pay the taxes out of other savings. If they have to pay out of the funds in the regular IRA, it will reduce the potential for coming out ahead.

“People should get independent advice from somebody who is not selling anything,” said Gary Schatsky, a financial planner in New York. “The question of whether this is right or wrong for you is too big to let public relations campaigns sway you.”

Q: How can people use their IRAs for a down payment on a house?

A: That’s pretty simple. People with a Roth IRA can withdraw up to $10,000, penalty-free and tax-free to pay for a first home.

People with a regular IRA can also take out up to $10,000 without paying the 10 percent penalty for early withdrawals. But they will have to pay taxes on the money.

Q: How about using IRAs to pay for college?

A: There will be several options. Savers can tap regular IRAs and Roth IRAs penalty-free to pay for college. Education withdrawals are allowed for the account holder, a spouse, child and grandchild.

But income taxes will be due on money taken out of regular IRAs. Taxes will have to be paid on investment earnings withdrawn from a Roth IRA if the account holder is younger than 59-1/2.

People can deposit another $500 a year in an education IRA, which can be opened for any child under 18. Contributions are made with after-tax dollars, and withdrawals to pay for college are tax-free. However, since annual contributions are limited to $500 per child, the accounts will only cover a fraction of the cost of a college education.

John Michel, a marketing executive with Merrill Lynch, said if a person starts saving now for a baby born this year, the account would build to $24,000 when the beneficiary is 20, assuming an 8 percent rate of return.

“That’s not going to pay for Harvard, but it will clearly be a help,” said Michel. Merrill Lynch is marketing education IRAs to grandparents, who get a “gift certificate” to present to their grandchildren when they open an account.

“It’s an opportunity for grandparents to give something that will keep paying their grandchildren back,” said Michel.