02/13/98

Switching to the New Roth IRA?

There is little doubt that making annual contributions to a new Roth IRA is a good retirement planning choice for anyone who can do so. But the question of switching existing Individual Retirement Account assets into a new Roth IRA is not so automatic. Considering the benefits and consequences is an important first step before converting an old IRA into a new Roth IRA, followed by thorough analysis of how such a move could affect your current and future financial circumstances.

Knowing that Roth IRA assets can be withdrawn tax-free at retirement, many individuals have an immediate urge to switch, but benefits of a Roth conversion depend heavily on the specific situation. Careful consideration of all the factors - including the immediate tax obligation of switching-- is required before deciding that a move to a Roth is the best course. In every case, it is a highly individual decision that must be based on personal financial circumstances.

The "Mechanics" of Switching:

Rules governing all IRAs (there are income limits to qualify for the Roth conversions, for instance) are many and varied. But assets in the traditional IRA grow tax-deferred, and Roth IRA assets grow tax-free -- potentially offering considerable benefits. A key distinction between the two is that income taxes on a traditional IRA are due at withdrawal. With a Roth IRA conversion, taxes are due at the time of conversion. Persons may switch existing IRA assets to a new Roth IRA without paying the usual early-withdrawal penalty. And while such converted funds are taxable at the time of the switch, a special provision for the "switch year" of 1998 will allow taxpayers to spread the tax obligation over four years. (You can convert a portion of your old IRA if desired.)

Some Items To Look For:

So, pay Uncle Sam now, or later? Roth conversion considerations include, among others:

• Amount of assets being converted -- You have to pay Roth IRA conversion taxes from current "out-of-pocket" income. The question is, can you? Can you produce the tax dollars on, say, a five- or six-figure investment pool, immediately -- or even over the next four years -- from take-home pay or other assets?

  The other question is, should you? You must compare the current tax cost with potential future tax savings:

• Taxable portion of the conversion -- This includes your pre-tax contributions, all earnings, and pre-tax employer contributions in the plan to be converted.

• Tax bracket at the time of conversion -- Beyond the "out-of-pocket" consideration, will the "added income" of assets from a traditional IRA (as you switch them to a Roth IRA) move you into a new, artificially high tax bracket? If it does, this of course increases your overall tax burden.

• Years to retirement -- If you're a long way from retirement, the years between now and then give you more opportunity to recoup the "tax costs" of a Roth conversion, perhaps making it a more viable alternative. (Again, it will be necessary to determine how much is taxable.)

These factors are as different for families as families are themselves. A comprehensive look at your current and future financial situation, as part of your overall financial plan, can provide the perspective needed to answer questions about whether converting to the Roth IRA is right for you, and exactly how much it might cost you in current taxes.

Are you making the right decision, financially? For a no-cost analysis of a Roth conversion or establishing a new Roth IRA, contact Don Coffin at (203) 281-7018 or, via email at: don.coffin@snet.net.

Please send questions or comments to dcoffin46333@wradvisors.com.