You have decided to jump into a new tax-free Roth IRA by moving $60,000 in mutual funds from your current individual retirement account into a new Roth account.
A standard Roth conversion. That means you can't take the money out tax-free until it has been in the account for five years, and you've turned 59 1/2 years old.
You also know the law considers that $60,000 a withdrawal from your IRA so you want to make the conversion this year because you are allowed to spread the tax bill over four years. You would add $15,000 a year to your income, but you know you can afford the extra taxes. Next year, you would have to pay taxes on the entire $60,000 in one year.
But, in fact, rushing could get you into trouble.
Here's why: You convert $60,000 now, but by Dec. 29, the market is down and those funds lose value and are worth $50,000.
Do you owe taxes on $50,000 or $60,000? The $60,000, of course.
Or, come Jan. 31, 1999, you and your spouse get your W-2 forms, add up your earnings and other income, and find you made more than $100,000 in 1998, which voids your eligibility for the Roth conversion.
Well, help is on the way. Congress has submitted a technical correction bill to alleviate some of those problems. The bill already has passed both houses but is part of the Internal Revenue Service reform legislation now in confer-
ence committee, though experts expect Congress will leave the technical correction bill alone.
The major change is a put-back period. For example, in January 1999, you find your income is over the limit. You can withdraw the money from the Roth and put it into a new IRA, on which the earnings are taxable, without penalty. But you have to do it by tax deadline, April 15.
That same change, tax experts said, would also help you if the market dropped, and you didn't want to pay taxes on money no longer in your account. But here is the catch: You can't wait until April 15 to put the money into a new Roth, and still take advantage of the four-year tax spread. The deadline for that is Dec. 31, 1998.
There is, however, a way around that. If the market has fallen and you are going to get stuck with taxes on money that no longer exists, withdraw the money from the Roth account, and put it into a new regular IRA. Then open a new Roth and switch the money back in, at the lower value, so your tax bill will be less. Tax experts say it can be done that way as long as you do it all by the Dec. 31 deadline.
But why race into a conversion? You have time to see where the market is going. The money in your current IRA is still growing without taxes, so there is no harm in waiting in a year in which the market has been volatile.
But there is no reason to wait to open a regular Roth account that doesn't involve a conversion. You start the five-year clock running sooner, which is why millions of people seem to be rushing to open those accounts now. IRAs had been relatively moribund until the Roth. Most people are opening regular Roth accounts.
For the record, mutual fund companies and brokerages love the Roth IRA for several reasons, not the least of which is the load of new money coming in. But a corollary reason is that it may take longer to leave.
Individuals who have a regular IRA must start withdrawing money from it at age 70 1/2 . But the Roth has no withdrawal requirements. And many companies, including T. Rowe Price in Baltimore, are pushing it as an estate-planning device.
Why? Well, if you name your granddaughter beneficiary and she starts collecting when she is 5, she could, in theory, withdraw money tax-free for another 80 years. That means that the company has your account for however long you live, then
during your granddaughter's life and keeps collecting fees, which get larger as the account keeps growing.
"We call it persistency of assets," one financial services executive said. Persistency of fees would be more like it.
By the way, there is one break that people who are 70 1/2 and have to withdraw money from their regular non-Roth IRA won't get. The minimum required distribution, the amount that must be withdrawn from the account, counts as income for a Roth conversion. That could prevent some people from converting to a Roth IRA if the required distribution puts them over the $100,000 limit. Congress isn't expected to change that in the current bill.
Pub Date: 6/28/98