Advantages Of Roth Ira Depend On Circumstances Pay Uncle Sam Now, Or Later. But Just How Much? And When?

These days, it’s not enough to know that you want an individual retirement account. Now you have to decide which kind.

Besides the traditional IRAs, there are the new Roth IRAs. But new doesn’t necessarily mean improved.

“In the next several months, you will hear more discussions on Roth IRAs vs. regular traditional IRAs than you will on whether Holyfield should fight Tyson again,” said Bud Kasper, a certified financial planner and president of Financial Security Investment Advisors Inc. in Lee’s Summit, Mo.

Roth IRAs allow investors to give up a potential tax deduction now in exchange for tax-free income in retirement.

Traditional IRAs offer immediate tax deductions of up to $2,000 for many taxpayers if they agree to pay regular income tax rates when they retire. New rules make those deductions a little easier to get.

Moreover, owners of traditional IRAs can convert them to Roth IRAs.

Ann League of Mission, Kan., who retired recently, plans to do just that. She’ll have to pay more income tax for the next four years. But when she takes money out of the Roth account, it will be tax-free.

“When I get my account statements from now on, I’ll know all the money there is mine,” League said.

Ernie and Ann Oeding of Lee’s Summit have decided to stick with their traditional IRAs. They hope their tax rate will be far lower when they retire in two decades or so.

Rodney Beard, a dentist in Liberty, Mo., disagrees. He’s not switching to Roth IRAs himself, but he is urging his four grown children - all starting their own medical careers - to open Roth IRAs instead of traditional IRAs because of the prospect of higher future tax rates.

“IRA deductions at this stage of their careers won’t mean as much as tax-free income later,” Beard said.

John and Dorothy Curty of Independence, Mo., are sticking with their traditional IRAs. Switching would tie up their retirement savings for the next five years, and they hope to tap the accounts sooner than that.

Personal finance experts predict many people ultimately will pick Roths. But they also say the choices remind them of a game of solitaire: There are only a few basic rules and an infinite number of ways to play and win.

Some ground rules for all individual retirement accounts were changed by the Taxpayer Relief Act of 1997.

“The biggest break with the past is the Roth IRA,” said Nicholas Kaster, an attorney and pension plan specialist at CCH Inc. in suburban Chicago.

A Roth IRA is open only for after-tax dollars. You get no tax savings at the time you make contributions. However, as with a traditional IRA, investment gains inside the account aren’t taxed yearly.

Kaster said vital differences will start showing up once the first Roth accounts are 5 years old, and as the account owners reach at least 50 years old.

That’s when Roth IRA owners can begin withdrawing any amount they want. When they do, the money won’t count as income on their next tax return.

Kaster said Roth owners will do more than save on income taxes in the future.

Because Roth distributions won’t count as income, retirees who also draw Social Security will find that those benefits are less likely to be taxed. Roth owners who have taxable income from other sources will find it easier to itemize tax deductions, because income-related thresholds, such as for medical deductions, will be lower.

Roth IRA owners aren’t required to start taking money out of their plans after age 70. Traditional IRA owners are required to do so whether they need the cash or not.

“This is a significant feature that may not be sufficiently appreciated,” Kaster said.

“Many people over age 70 still have long lives ahead of them,” he said. “Some will be working still, or may have enough income from existing retirement plans to meet their current needs. The Roth IRA gives them a good way to save additional funds for use in their coming decades of life, or to pass on to their beneficiaries.”

You can open a Roth IRA this year regardless of whether you have other IRAs or retirement plans. That makes them especially appealing in households where someone is covered by an employer’s retirement plan. The coverage often prevents them from deducting contributions to a regular IRA.

You also can convert a traditional IRA to a Roth IRA. However, individual circumstances can make those decisions complicated.

There is one situation where there is no choice. Any single or jointly filing married taxpayer with an adjustable gross income of $100,000 or more can’t convert traditional IRAs to Roth IRAs.

Income ceilings also limit who can open a Roth IRA. Single taxpayers can’t open a Roth IRA if their 1998 income exceeds $95,000. Married joint filers can’t if their 1998 income exceeds $150,000.

If you don’t have too much income to convert your IRA, there are three broad questions to answer to determine the best move for you.

Money converted from a traditional IRA to a Roth IRA will be tied up for five years or more. Account owners won’t have access to it.

If the five-year tie-up of a Roth conversion isn’t a problem, advisers say, an immediate tax bill might be.

The tax burden will vary according to whether original contributions to the IRA had been deducted. But basically, the federal government counts money pulled out of a traditional IRA for a conversion to a Roth IRA as ordinary income and taxes it just like a paycheck.

For some, the taxes could be hefty.

Taxpayers might be tempted to use some of the IRA money to pay the taxes. But that will trigger a 10 percent early withdrawal penalty because all the IRA money won’t make it to the Roth account. A better choice is to pay the taxes from other sources.

Taxpayers such as League who convert this year get a special one-time break of sorts: They can spread these tax payments over four years.

Anyone who waits until next year or later to convert must pay the entire tab at once.

A third vital issue is whether you expect your taxes in retirement will be higher or lower than the tax rate you pay now.

Answering this one is a crap shoot, the experts say. No one can predict confidently what tax rates will be two years from now, much less in 10, 20 or 30 years, when many IRA holders will be cashing in.

But as a general rule, authorities say, traditional IRAs will make the most sense if you expect your future tax rate to be much lower than your current rate. Roth IRAs will be the better choice if your future tax load turns out to be about the same or greater.

The new tax laws also changed some features of traditional IRAs that make them more competitive with Roth IRAs.

Beginning this year, more taxpayers will be able to take an annual deduction for investments in traditional IRAs. The income ceiling that previously cut them off is being notched higher annually through 2007.

Anyone who isn’t covered by a retirement plan offered by their employer or their spouse’s employer can take the deduction, regardless of income. Anyone who is covered but whose income is too high to take a deduction can open or add to traditional IRAs to make tax-deferred investments.

Lawmakers also loosened some restrictions on early withdrawals from traditional IRAs to make those features more like those offered by Roth IRAs.

Taxpayers with either kind of IRA can pull as much $10,000 from the accounts to help them or a close relative buy a home without paying early withdrawal penalties. Similar withdrawals, but without dollar limits, are possible for college or major medical expenses.

There is a tradeoff. Penalties are waived for these early withdrawals, but potential income taxes aren’t. Even Roth money can be taxed if it is withdrawn too early. And if that happens, the money will be taxed at ordinary income rates, not the new lower capital gains rates created by last summer’s law.