Two New Tax-Saving IRAs
Individual Retirement Accounts (IRAs) became more attractive on January 1, 1998, with the creation of the “Roth IRA” (named for Senate Finance Committee Chairman William Roth of Delaware) and the new “Education IRA.”1
Specifically: A Roth IRA doesn't qualify you for a tax deduction, but all qualified earnings and withdrawals will be tax-free after five years when you begin withdrawing and are at least 591/2 years old. Another advantage of the new retirement account is that it has much higher income limits for eligibility than the traditional, deductible IRAs. Singles with an annual adjusted gross income (AGI) of less than $110,000 and married couples filing jointly with an AGI of less than $160,000 are eligible for the new IRA. By contrast, the AGI limits of the traditional IRA are under $30,000 for singles and below $50,000 for couples filing jointly in 1998.
The combined maximum that can be contributed into either type of IRA remains the same at $2,000 per year, but with the Roth account, you can continue to make annual contributions after age 701/2.
In the case of a married couple filing jointly, up to $2,000 can be contributed to each spouse's IRA (even if one spouse has little or no compensation). This means that the total contributions that can be made to both types of IRAs can be as much as $4,000 annually.
Withdrawals up to $10,000 from any IRA can be made before age 591/2 without paying a 10% penalty only if the money is used to buy a first home or pay for college tuition. However, withdrawals will be subject to income taxes.
Mandatory distributions are not required from a Roth IRA at age 701/2 as they are with traditional IRAs. With a Roth account, you can decide your own timetable for withdrawals or choose not to withdraw any funds after the five-year holding period. In fact, you never have to take any distributions.
Younger workers may especially benefit from these provisions because they have many working years ahead to make contributions and accumulate a large nest egg of tax-free cash for when they retire.
Single or married taxpayers can convert a traditional IRA to a Roth account if their income for the year is $100,000 or less, but they have to pay tax on the value of the converted IRA.
Whether you should choose a Roth IRA over a traditional one depends on your specific situation, such as how many years remain before retirement, your present and future tax-brackets, and your goals after retirement. You should discuss which IRA suits you best with a lawyer, financial, or investment adviser before making a definite decision.
Depending on their income levels, many families (including many middle-class households) can qualify for the new “Education IRA,” a nondeductible savings account set up to pay for their child's college expenses. The account, which is similar to an IRA, enables qualifying parents to contribute up to $500 per year for each child under 18 years old and allows the earnings to grow tax-free. However, you do not qualify if you are contributing to a qualified state tuition program.
Unlike the other IRAs, there is no requirement that the contributor have any earned income or be under age 701/2. Married couples filing joint returns with adjusted income of $150,000 or less and singles with an adjusted income of $95,000 or less, are permitted to make the full $500 contribution. The allowable contribution diminishes with higher income levels.
Summary of IRA Choices
Traditional, deductible IRA
Eligibility: Persons who do not participate in an employer's retirement plan; those who do but are married and file jointly, and have an annual AGI under $50,000 in 1998; and single persons whose AGI is less than $30,000 in 1998.
Tax Rules: Contributions and earnings are not taxed until withdrawal. Must begin to take distributions at age 701/2. Distributions taken before age 591/2 are subject to a 10% penalty except in cases where withdrawals up to $10,000 are used for purchasing first home, or for education.
Eligibility: Married persons filing jointly whose AGI is less than $150,000 in 1998 and single persons whose AGI is under $95,000 in 1998.
Tax Rules: Contributions are not tax deductible. Earnings and withdrawals are not taxed as long as the account is held for five years and account holder is at least 591/2 years old when distributions are taken. No minimum withdrawals required at age 701/2. Distributions taken before age 591/2 are subject to a 10% penalty except in cases where withdrawals up to $10,000 are for purchasing first home, or for education.
1.The new retirement accounts discussed here are only meant to provide readers with general information and are not intended to cover the subject in its entirety. These IRA changes do not apply to 401(k) and Keogh retirement plans.