So now that you have all these new Individual Retirement Account and capital-gains tax options, how will you buy, sell or hold your mutual funds?
Buy them through your 401(k)?
Buy them through the new Roth IRA, hold them for five years and then take the profits tax free?
Roll over your old IRA into a new Roth IRA?
Buy bonds outside an IRA so you can pay the low capital-gains rate when you sell?
Figuring out what to do, and when, is going to be somewhat confusing. There are no simple answers -- and some of the questions people are raising are based on false assumptions. But here are two quick warnings to those who have heard about the so-called tax-free Roth IRA . This is the new account that seems to allow you to take your money out tax-free after five years.
The first caution is that the most important letter in "IRA" is the "R" for "retirement." You can't get the money out tax-free at just any age after five years; you must be 59 1/2 years old, though there are some exceptions. You will be able to take the money out tax-free after five years, regardless of age, to pay medical expenses or for a college education. And up to $10,000 may be withdrawn for a first-home purchase.
The second caution is that this tax-free IRA may not be around forever. Congress has a history of playing with IRAs. However, Randall Weiss, director of tax economics for Deloitte & Touche in Washington, said: "I would be surprised if it went back on its word that the money is tax-free. They just might say no new contributions at some point in the future."
So, with the new tax law in mind, here is a look at some of the options to consider when you are buying funds, or stocks and bonds, for the long haul:
A 401(k)-type investment, Roth IRA, or both.
While some experts have suggested that the tax-free benefits of the new IRA might make it better in the long run than a 401(k), most disagree. For one thing, notes Ellen Breslow, director of individual retirement services for Smith Barney, the IRA contribution is limited to $2,000 a year. "The limits on 401(k)s are just much higher ($9,500), the contribution is deductible from your income (for the Roth IRA, it isn't), and there may be a company match," she said. Another advantage: You can take a loan from your 401(k).
The Roth IRA has two advantages. You can take your contributions and the profits tax-free at retirement, and you can pick your own investments. The 401(k) money is subject to ordinary income tax at retirement, though you can control your tax bill by how much you withdraw. And you get a limited choice of investments picked by your employer.
Robert Katz, a Westbury, N.Y., tax lawyer who teaches taxation at Hofstra University, said that if you can afford both, you should do both. For young people who can afford the $2,000 or any part of it, the Roth IRA makes particular sense. Even if it disappears in 10 years, you probably will be able to take the earnings at retirement tax-free, and 20 to 40 years of tax-free growth could amount to a small fortune.
Tom Ochsenschlager, director of tax policy for Grant Thornton in Washington, said the contributions, but not the profits, can be withdrawn from a Roth IRA account at any time without tax liability. That differs from current IRAs, which require a proportional withdrawal of both contribution and profit, which is taxable, he said.
Roll over your old IRA into a new Roth IRA.
This one is tricky because the adjusted gross income limit for a Roth IRA is $150,000 a year, but the income limit for those wanting to roll an existing IRA into a Roth is $100,000.
The question of whether a rollover makes sense for you is really another math problem. It is also, tax experts and financial planners say, very age sensitive. You will pay ordinary income taxes on your withdrawal, which is how the IRS views your rollover. If it's large, it can throw you into tax brackets you never dreamed of. The balance would then go into the Roth IRA.
If you are young, you have time to make up for the money lost to taxes, accountants say. But the older you are and the larger the tax hit, the less time you have. If you open a Roth IRA in 1998 and roll your old IRA into it, you will have four years to pay the taxes on the rollover withdrawal.
Forget the IRAs. Just invest and pay the new, low capital-gains rate.
Don't worry too much about the IRAs, said Melville, N.Y., financial planner Joseph Clinard. "If you have an IRA, put your fixed-income investments in it, but keep the growth funds out and just pay the low capital-gains rate." The reason: The interest on bonds is taxable annually at ordinary rates but can be reinvested tax-free in an IRA.
The new capital-gains rate is only 20 percent on securities held longer than 18 months.
You will pay taxes on the growth funds' capital gains and dividends, which you wouldn't in the other account. But if you take money out of a conventional IRA later, you can pay as much as 39.6 percent in federal income taxes, plus state and local income taxes, which can push the tax bite close to 50 percent.
One caution from New York City financial planner Joel Isaacson: Don't put tax-free investments like municipal bonds in a tax-advantaged account like an IRA or 401(k). Not only is it unnecessary, but it turns the tax-free earnings into taxable ones when you withdraw the money.
Pub Date: 8/31/97