New IRA is on deck, expected to be big hit

Investing

October 20, 1997|By Bill Atkinson

AFTER YEARS of being snubbed by investors, the individual retirement account is on the verge of making a comeback.

Thanks to Congress and the recently passed "1997 Taxpayer Relief Act," the IRA should become one of the hottest investment vehicles around when the new and improved version is offered next year.

The new tax law created the "Roth IRA," named after Del. Sen. William V. Roth Jr., chairman of the Senate Finance Committee. And banks and mutual fund companies can't wait to start offering it.

"It will breathe new life into" the IRA, said Thomas Towne, senior vice president with Universal Pensions Inc., a Brainerd, Minn.-based retirement services consulting firm. "Many of the restrictions that were in place for the traditional IRA have now been lifted. There is definitely going to be a greater inflow of dollars."

About $1 trillion has been invested in IRAs, according to Universal Pensions. But investors have given them the cold shoulder since the Tax Reform Act of 1986 turned IRAs into a lousy investment. The legislation placed strict limits on who could put money into them, and it tightened up on deductions.

In 1986, people pumped $38.3 billion in IRAs. But after the act was passed, contributions plunged to $14.9 billion the next year, and they have continued to slump. Last year, about $11 billion was contributed to IRAs, Universal Pension says.

The new IRA offers several features that make it so attractive that investors will at least have to take a look.

For example:

Contributions to the new IRA are not deductible from current income, but taxes on the earnings are deferred, and the money can be withdrawn tax-free after age 59 1/2 , if the account has been open for at least five years. This is a significant change because, while earnings in current IRAs are deferred, they are taxed when the money is withdrawn.

Contributions to the Roth IRA can be made even after the investor turns 70 1/2 . Current law requires the investor to take distributions when they turn 70 1/2 . So, investors can accumulate as much as they want and pass the money on to their heirs after they die.

The law also enables all IRA investors who are younger than 59 1/2 to withdraw money from their accounts for college expenses and for the first-time purchase of a house without having to pay the 10 percent early withdrawal penalty.

The new IRA is intended to spur savings among the middle class.

Individuals with adjusted gross income up to $95,000 can contribute $2,000 annually to the new IRA.

And married couples who make up to $150,000 in adjusted gross income can contribute $4,000.

Individuals who earn from $95,000 to $110,000 and married couples who make $150,000 to $160,000 can make partial contributions.

People who have higher income levels cannot contribute.

IRA savings can be converted to a Roth IRA, but the investor who makes the switch will be hit with taxes on any earnings.

"The key is, you will be able to withdraw the money tax-free when you retire," said Edward F. Giltenan, a spokesman with T. Rowe Price Associates Inc. in Baltimore.

A 30-year-old who invests $2,000 a year in a Roth IRA will have accumulated $372,204 by the time he's 65, assuming an annual return of 8 percent.

After he retires, that investor would be able to withdraw $32,835 a year from the account for 20 years -- or $656,700 -- because the IRA still would be growing, and withdrawals are not taxed.

"Everything you take out of the Roth goes into your pocket," Giltenan said. "The Roth just pulls way ahead because the withdrawals are not being taxed."

But the Roth IRA isn't for everyone.

Experts advise investors to crunch their own numbers on work sheets or software packages to see whether it is worth the investment.

"You have to look at all of the variables," Towne said. "It really takes modeling."

Pub Date: 10/20/97

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