This Article is designed to be of general interest. The specific techniques and information discussed may not apply to you. Before acting on any matter contained herein, you should consult with your personal legal adviser.

See Roth IRA UPDATE

If you qualify, the traditional deductible IRA allows current income tax deductions for contributions, and tax-deferred growth of the earnings. The entire contents of the fully deductible IRA are pre-tax funds, subject to taxation (and possibly penalty) when disbursed.

A non-deductible IRA allows current non-deductible contributions for individuals who make too much to qualify for deductible IRAs, but permits tax-deferred growth of the earnings. This means that some funds (the earnings) are pre-tax, and some are post-tax (the contributions). When withdrawn, a portion (the proportion not deductible when contributed) is tax-free; a portion (the earnings) is taxable.

When you hit age 70½, the minimum distribution rules require taking funds out of either of these tax-advantaged IRAs (and paying tax at that time). Whatever you have left at death is subject to both income taxes in your heirs' hands and the date of death value is subject to death taxes in your estate.

The new Roth IRA allows no deduction for contributions. It has no minimum distribution rules, and you can make contributions even after age 70½. You can withdraw it tax free. Anything remaining will go to your heirs, income tax free, although the value at your death is subject to death taxes in your estate.

The Basics
Annual Contributions: You may contribute $2,000 (if your "earned" income is at least that amount) to any IRA; so can a non-working spouse. [This limit is the annual total allowed for all IRAs; you can divide it any way you want between all of your IRA contributions in any year.]

Income Limits: The limit for annual contributions to a Roth IRA is $110,000 modified Adjusted Gross Income for a single person; $160,000 for a Joint Return.

Rollover: You can roll your traditional (or non-deductible) IRA into a Roth. There is no limit on how much may be rolled over. You may roll any portion over. [It's not an all or none deal.] However, a SEP-IRA or SIMPLE Plan may not be converted into a Roth.

Income Tax on Conversion: Since the old IRA holds pre-tax money, and the Roth holds after tax funds, you pay income tax on the conversion. If you convert in 1998, you may spread the tax over 4 annual payments.

Rollover Income Limit: If you make more than $100,000 modified Adjusted Gross Income (without counting the rollover), you cannot convert into a Roth IRA.

• Some question exists as to whether a married couple is allowed double this $100,000 limit, due to vague language used by Congress.
• People who are married filing Separate Returns may never convert into a Roth IRA!

Year-End Corrections: You might not know if you qualify under the income limitations, until the year is closed. Therefore, the new law appears to allow moving funds between Roth and traditional IRAs until the (extended) due date of your return.

Penalties: A 10% penalty applies unless you wait 5 years before making a withdrawal of the profits (unless you are 59½ or meet another exceptions).

Assume that you qualify. Should you convert/ contribute annually to a Roth? That's the hard question.

I have $2,700 to invest. If I put $2,000 into a traditional IRA I save 35% combined Federal and State tax. I then have $2,000 growing tax deferred in my IRA and $700 in my regular investment account since I saved 35% in taxes.

I contribute nothing more and leave everything alone for 20 years, earning 12%. My IRA has grown to $19,293; my original $700 investment account, after paying annual 35% tax (on earnings) is $3,144.

Then I take out my whole IRA, paying 35% tax, and add it to my regular investment account. I then have $15,684 of after tax money to spend.

Conversion of an existing IRA into a Roth.

Instead, if I convert into a Roth today, and pay $3,500 of tax now, my $10,000 Roth IRA grows to an after tax spendable $96,463.

These simplistic examples illustrates the power of compounding and the apparent power of the Roth IRA. But are these accurate? Yes or no.

Making these comparisons is very easy once the basic assumptions are made. However, the underlying assumptions are the difficult part of the process.

If you can tell me 4 facts, I can tell you conclusively whether the Roth is right for you:

1. What tax bracket are you in today? That's easy.
2. How long will you let the IRA grow? That's not as easy. Age 65? Maybe age 75? Maybe age 85? Maybe you never need those funds.
3. How much will it make? That's even harder to project.
4. What tax bracket will you be in when you withdraw the money?

The last factor may be impossible to predict. Look back 20 years. Could you have guessed then what tax brackets would be today, let alone in which bracket you would be? Look at the tax law changes we have had in 20 years!

Now project forward. When you expect to pull the money out of the IRA, what changes will have occurred to our tax laws? Will brackets be up or down? Will the Tax Code be entirely re-written before then? Will we have any income tax or perhaps a national sales tax instead?

Here's the scariest thought. Let's look at the conversion example and assume that in 19 years, Congress eliminates the income tax entirely.

• Back in 1998, you converted your $10,000 IRA into a Roth and paid $3,500 in tax. In 2018 you have $96,463 in the Roth IRA and it is all tax free.
• I never converted. My regular IRA also grows to $96,463 by 2018 when they made everything income tax free, but I also have had the $3,500 (which you paid in tax) growing into $15,720 (after paying tax on the earnings each year).

Rules of Thumb: Most of these do not work; you must run the numbers with your tax adviser.

One rule of thumb which works every time is that if you (or your child/grandchild) is in the zero percent bracket, do a Roth!. Now, the only problem is me finding a legitimate way to pay my 4 year old a $2,000 a year salary so I can open a Roth IRA for her.

Estate Planning If you can afford to leave the IRA to your children, the exemption of the Roth IRA from the minimum distribution rules creates huge compounding opportunities.

I have attended a dozen seminars regarding the minimum distribution rules for regular IRAs. These rules require taking money out of IRAs (and paying taxes), once you hit age 70½.

Most people need their IRAs for retirement, and do not have the option to postpone dipping into IRAs, but for those who are able to wait longer, careful analysis of the minimum distribution rules shows that postponing withdrawals as long as possible, creates greater tax deferred growth for your children and grandchildren.

There is no question that the best long-term strategy for your heirs is to convert it into a Roth, pay the tax, die and leave it to your children, who can then try to stretch it out as long as possible. The extra growth due to tax deferral is astounding.

Many of my clients (1) need/want to spend their IRAs, and don't have the option of not using it, or (2) have children who will just spend it after Mom and Dad die, so why bother trying to stretch it out as long as possible?

Detailed examination of these rules is beyond the scope of this article, other than to state that the minimum distribution rules do not apply to Roth IRAs and should be considered another advantage worth examining.