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It's a whole new IRA world

The Taxpayer Relief Act of 1997 made a host of changes to the U.S. tax code. For people approaching retirement, perhaps the most significant changes concern the new rules for IRAs.

"Older Americans saving for retirement will want to pay close attention to the new rules, particularly the introduction of a new type of IRA," said Sam Van Why, an academic associate at the College for Financial Planning. "IRAs will play a larger role in retirement planning than ever before."

Van Why outlines three key changes to individual retirement accounts:

Income limitations eased.

Workers not covered by a company-sponsored retirement plan (and spouses also not covered) can contribute up to $2,000 a year tax deductible to an IRA. However, for workers covered by a company plan, that deductible contribution begins to phase out once their adjusted gross income reaches certain limits: $25,000 for singles or $40,000 if married filing jointly. The deduction is completely gone by $35,000 ($50,000 for joint filers).

The new law raises those income limits starting next year. The phaseout for single filers and heads of households won't start until $30,000 ($50,000 jointly), and it won't disappear until $40,000 ($60,000). By the year 2005, the phaseouts won't begin until $50,000 for singles ($70,000 jointly) and won't be gone until $60,000 ($80,000). The limits rise even more for joint filers by the year 2007 ($80,000 to $100,000).

"Spousal taint" removed.

Currently, a non-working spouse or a working spouse who is not covered by a retirement plan cannot make a tax-deductible contribution to an IRA if the other spouse is covered by a company-sponsored plan and their adjusted gross income exceeds the limits cited above. The "spousal taint" has been dropped _ to a limit. The spouse can now contribute to an IRA as long as the couple's adjusted gross income does not exceed $160,000 (it starts to phase out at $150,000).

New Roth IRA.

Probably the biggest issue facing those approaching retirement is the question of whether to shift money from their current IRAs into the new Roth IRA, which becomes available in 1998. With a regular deductible IRA, the taxpayer receives a tax deduction on the contributions but pays taxes on the money, including earnings, when it's withdrawn. A Roth IRA works the opposite way: Contributions are not deductible, but withdrawals, including earnings, are not taxed as long as the money was in the account at least five years and you are at least 59{ (it can be withdrawn earlier in the event of death or disability).

As with traditional IRAs, there are income limitations. Roth IRA contributions start to phase out for taxpayers with adjusted gross incomes of $95,000 ($150,000 for joint filers) and disappear by $110,000 ($160,000). Also, the $2,000 contribution limit reflects the total contributions to deductible IRAs and the Roth IRA.

"Taxpayers with money in regular IRAs can shift that money free of any 10 percent early withdrawal penalty into a Roth IRA," Van Why said. The catch is, they'll have to pay income taxes on the transferred funds. Fortunately, if they roll over the money next year, they can spread the income out over four years for tax purposes. Is the rollover worth it? That depends on several factors.

If the IRA owner's tax rate is the same at the time of the rollover and when the money is later withdrawn to help pay for retirement, the end dollar amount after taxes is the same regardless of which type of account you choose. This assumes that everything else remains equal (the return on the money in the accounts, the length of time the money is in the accounts, etc.).

"The major advantage of the Roth IRA under this circumstance," said Van Why, "is that there are no minimum withdrawal rules. The owner can leave the money in the Roth account until death. A minimum amount of money must be withdrawn each year from a deductible IRA (or IRAs) starting by April 1 following the year the IRA owner turns 70{."

If the IRA owner expects to be in a lower tax bracket when the money is withdrawn, as is often the case for retirees, then it's generally better to leave the money (or invest) in a regular IRA. If the reverse were expected, then the Roth IRA would probably be the better deal.

Van Why cautions that even if it appears to make sense to shift money from a traditional IRA to a Roth IRA, taxpayers need to take into account the fact they'll likely be bumped up into a higher income-tax bracket because of the rollover. "For people with small IRAs or in the lowest tax bracket, it might work out, but I question whether the rollover will be advantageous to most people," Van Why said.

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