Rollovers, Roths Boost the Allure of IRAs

By Clifton Linton
Senior Writer, mPower

In This Story Distribution Tool Roth IRA Kids Spousal IRAs Automatic Rollover

The humble IRA is often overshadowed by the 401(k) plan, whose higher contribution limits and features such as employer-matching contributions and loans have made it the darling of retirement savers. Yet, IRAs are holding their own as a savings option: 41 percent of American households owned at least one of these tax-deferred savings accounts as of June 2000, according to the Investment Company Institute (ICI).

Who's taking advantage of IRAs? IRA accounts seem to be increasingly popular as a repository for accumulated retirement wealth and as a savings vehicle for those without access to employer-sponsored retirement savings accounts, including kids and stay-at-home spouses.

minute: read this article at a glance.

Created in 1974 to give workers a tax-advantaged way to save for their own retirement, IRAs have been around about six years longer than 401(k) plans. Yet, with one notable exception (the Taxpayer Relief Act of 1997, which introduced Roth and Education IRAs, and made Spousal IRAs more attractive), most of the measures Congress has passed relating to IRAs have restricted their use, while 401(k)s have become more user-friendly.

Technical Terms Roth IRA Rollover Beneficiary

Many workers take a pass on contributing to IRAs if they're eligible to participate in an employer-sponsored retirement plan. For one thing, Congress made it harder for these workers to deduct IRA contributions when it imposed a maximum income level for eligibility in the 1980s. Also, the annual contribution limit has been fixed at $2,000 for years.

Laws currently before Congress propose raising the annual IRA contribution limit to $5,000 and raising income qualification limits. Further, workers over 50 would be allowed to make "catch-up contributions" if they were unable to make full annual contributions earlier in their working life. But, while many hoped for the changes to pass this year, they will likely fall prey to election-year squabbling.

Distribution Tool

In 1998, IRA assets topped $2.1 trillion and were expected to top $2.4 trillion in 1999, according to the Employee Benefit Research Institute (EBRI). The two leading factors driving this growth were stock market gains and rollovers from defined-contribution plans, such as 401(k)s. Indeed, in 1997 — the last year for which data is available — American workers rolled over more than $90 billion into IRA accounts, according to EBRI. That compares with only $8.7 billion in new deductible contributions to IRAs for that same year.

Rollovers from an employer-sponsored plan can take place when a worker changes jobs or retires. While many people think of an IRA primarily as a retirement savings vehicle, its real utility appears to be as a retirement wealth-distribution tool for retirees.

A growing number of employers are unwilling to absorb the administrative costs of managing periodic withdrawals for retired workers. This leaves retirees with the option of taking a lump-sum distribution and paying taxes on their plan savings all at once, or rolling the money into an IRA and paying taxes on periodic distributions. That's one reason why an increasing number of retirees will likely take periodic distributions from an IRA rather than a workplace retirement plan.

Some individuals are also using IRAs as a tool to pass on estate assets. Because IRAs are beneficiary-designated assets, the money can go directly to the heir and bypass the potentially lengthy and costly probate process.

Strategy: Roth Conversion The last year has been pretty tough on many who invested in the equity markets. If you were one of those folks, as you lick your wounds, consider this possible silver lining: This might be the ideal time to convert a traditional IRA to a Roth IRA, says Neil Downing, certified financial planner and author of Maximize Your IRA. The reason? "When you make a conversion, you need to pay tax on the amount you convert. Therefore, the higher the amount you convert, the more tax you pay," he said. "So, if the value of your IRA has declined because of market conditions, it'll now cost you less to convert." The catch: You must meet the income qualification limits to make a conversion.

If you want to pass on an IRA to your heirs, you need to pay close attention to how you name beneficiaries and calculate your withdrawals when you reach age 70½. For more on this subject, read Avoid Expensive Mistakes When Making IRA Beneficiary, Distribution Choices.

Roth IRA

Created by the Taxpayer Relief Act of 1997 and first available in 1998, the Roth IRA has become popular. According to ICI, 25 percent of households with IRAs in June 2000 had Roths. Most of those households owned one Roth IRA account with a median balance of $6,000.

Roth IRA holders contribute after-tax money to the account, and can withdraw the money and all future earnings tax-free if they meet the requirements.

Down the line, your heirs may toast you for passing on a Roth IRA to them. The reason is that they can also make tax-free withdrawals and, unlike traditional IRAs, Roth IRAs don't have minimum distribution rules.

"If someone walked in the door looking for advice (on what to save in), I would recommend they use a Roth," said Mari Adams, a certified financial planner in Boca Raton, Fla.

Kids

While statistics on kids' IRA ownership are scant, anecdotally there are signs that youngsters are starting to use these accounts as a savings tool.

Here's How Some Kids Are Doing It Read our account of nine-year-old Peter Gustafson and 15-year-old Nichole Ostner who are saving with IRAs.

The Roth IRA is an ideal tool for kids wishing to save for a variety of goals, financial planners say. Though the contributions will be taxed, the child will likely pay a lower tax rate than he or she will have during the peak earning years. The earlier the contributions begin, the more time the balances will have to grow with the power of interest compounding.

Saving for retirement is a difficult concept for many children to grasp. But, money in a Roth IRA can also be withdrawn without taxes or penalty for qualifying expenses such as college tuition or a first home. If the child doesn't need the money and can leave it alone until retirement, the account will benefit from decades of interest compounding.

Here's the catch: The child needs to have earned income — that is, compensation from participation in a business — in order to contribute to an IRA. That doesn't include allowance, gifts or interest income.

Strategy: How Your Kids Help You Save The Taxpayer Relief Act of 1997, which created the Roth IRA, has a hidden nugget for families with kids — a $500 per child federal income tax credit. If a family qualifies for this credit, the money could be used to fund an IRA, suggests Certified Financial Planner Neil Downing, author of Maximize Your IRA.

Several mutual fund firms offer funds targeted to children. The funds have low initial investment requirements and their portfolios often include companies whose names children will recognize.

As a parent, it can be tough to set up an IRA for a minor, notes Certified Financial Planner Dee Lee, author of Let's Talk Money and The Complete Idiot's Guide to 401(k) Plans. "Many financial institutions don't want to deal with minors," she said, in part because of the custodial paperwork required for these accounts.

She recommends that parents carefully track the child's earnings and file a tax return documenting the earnings, even if they fall short of the reporting threshold.

The last thing you want to have happen is that the child is audited and the account disqualified. "I wouldn't want to give a kid that kind of lesson," says Lee.

Spousal IRAs

Compared with the last generation, many more American families now are two-income households. But, a fair number of families still have only one wage earner.

"If someone walked in the door looking for advice (on what to save in), I would recommend they use a Roth." — Mari Adams, a certified financial planner in Boca Raton, Fla.

The 1997 tax bill amended the IRA rules to increase contribution limits for stay-at-home spouses without earned income. The law had two key elements that have spurred interest in spousal IRAs. First, the annual contribution limit was raised to $2,000 from $250. Second, the law made it possible for the stay-at-home spouse to deduct his or her contribution even if the working spouse could not.

If the employed spouse is participating in a qualified retirement plan at work and earns more than $62,000 in annual salary in 2000, he or she is not allowed to make a tax-deductible contribution to an IRA. However, the nonworking spouse can make a deductible IRA contribution providing the couple is filing a joint tax return and has adjusted gross income less than $150,000.

For more on spousal IRA rules, read Spousal IRAs: Empowering the Single-income Family.

Automatic Rollover

One factor likely to boost IRA ownership over the next few years is this summer's IRS ruling that will allow employers to automatically open an IRA for former employees who leave a 401(k) balance with less than $5,000 and don't roll it over or take the cash within a certain amount of time.

Related Reading Peter's Roth IRA Young Savers Learn Valuable Money Lessons with Roth IRAs Avoid Expensive Mistakes When Making IRA Beneficiary, Distribution Choices

Participants with balances of $5,000 or more, by law, are entitled to leave their money in the former employer's plan.

The ruling is unclear as to how the money will be invested in the IRA. 

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

Rollovers, Roths Boost the Allure of IRAs

By Clifton Linton
Senior Writer, mPower

In This Story Distribution Tool Roth IRA Kids Spousal IRAs Automatic Rollover

The humble IRA is often overshadowed by the 401(k) plan, whose higher contribution limits and features such as employer-matching contributions and loans have made it the darling of retirement savers. Yet, IRAs are holding their own as a savings option: 41 percent of American households owned at least one of these tax-deferred savings accounts as of June 2000, according to the Investment Company Institute (ICI).

Who's taking advantage of IRAs? IRA accounts seem to be increasingly popular as a repository for accumulated retirement wealth and as a savings vehicle for those without access to employer-sponsored retirement savings accounts, including kids and stay-at-home spouses.

minute: read this article at a glance.

Created in 1974 to give workers a tax-advantaged way to save for their own retirement, IRAs have been around about six years longer than 401(k) plans. Yet, with one notable exception (the Taxpayer Relief Act of 1997, which introduced Roth and Education IRAs, and made Spousal IRAs more attractive), most of the measures Congress has passed relating to IRAs have restricted their use, while 401(k)s have become more user-friendly.

Technical Terms Roth IRA Rollover Beneficiary

Many workers take a pass on contributing to IRAs if they're eligible to participate in an employer-sponsored retirement plan. For one thing, Congress made it harder for these workers to deduct IRA contributions when it imposed a maximum income level for eligibility in the 1980s. Also, the annual contribution limit has been fixed at $2,000 for years.

Laws currently before Congress propose raising the annual IRA contribution limit to $5,000 and raising income qualification limits. Further, workers over 50 would be allowed to make "catch-up contributions" if they were unable to make full annual contributions earlier in their working life. But, while many hoped for the changes to pass this year, they will likely fall prey to election-year squabbling.

Distribution Tool

In 1998, IRA assets topped $2.1 trillion and were expected to top $2.4 trillion in 1999, according to the Employee Benefit Research Institute (EBRI). The two leading factors driving this growth were stock market gains and rollovers from defined-contribution plans, such as 401(k)s. Indeed, in 1997 — the last year for which data is available — American workers rolled over more than $90 billion into IRA accounts, according to EBRI. That compares with only $8.7 billion in new deductible contributions to IRAs for that same year.

Rollovers from an employer-sponsored plan can take place when a worker changes jobs or retires. While many people think of an IRA primarily as a retirement savings vehicle, its real utility appears to be as a retirement wealth-distribution tool for retirees.

A growing number of employers are unwilling to absorb the administrative costs of managing periodic withdrawals for retired workers. This leaves retirees with the option of taking a lump-sum distribution and paying taxes on their plan savings all at once, or rolling the money into an IRA and paying taxes on periodic distributions. That's one reason why an increasing number of retirees will likely take periodic distributions from an IRA rather than a workplace retirement plan.

Some individuals are also using IRAs as a tool to pass on estate assets. Because IRAs are beneficiary-designated assets, the money can go directly to the heir and bypass the potentially lengthy and costly probate process.

Strategy: Roth Conversion The last year has been pretty tough on many who invested in the equity markets. If you were one of those folks, as you lick your wounds, consider this possible silver lining: This might be the ideal time to convert a traditional IRA to a Roth IRA, says Neil Downing, certified financial planner and author of Maximize Your IRA. The reason? "When you make a conversion, you need to pay tax on the amount you convert. Therefore, the higher the amount you convert, the more tax you pay," he said. "So, if the value of your IRA has declined because of market conditions, it'll now cost you less to convert." The catch: You must meet the income qualification limits to make a conversion.

If you want to pass on an IRA to your heirs, you need to pay close attention to how you name beneficiaries and calculate your withdrawals when you reach age 70½. For more on this subject, read Avoid Expensive Mistakes When Making IRA Beneficiary, Distribution Choices.

Roth IRA

Created by the Taxpayer Relief Act of 1997 and first available in 1998, the Roth IRA has become popular. According to ICI, 25 percent of households with IRAs in June 2000 had Roths. Most of those households owned one Roth IRA account with a median balance of $6,000.

Roth IRA holders contribute after-tax money to the account, and can withdraw the money and all future earnings tax-free if they meet the requirements.

Down the line, your heirs may toast you for passing on a Roth IRA to them. The reason is that they can also make tax-free withdrawals and, unlike traditional IRAs, Roth IRAs don't have minimum distribution rules.

"If someone walked in the door looking for advice (on what to save in), I would recommend they use a Roth," said Mari Adams, a certified financial planner in Boca Raton, Fla.

Kids

While statistics on kids' IRA ownership are scant, anecdotally there are signs that youngsters are starting to use these accounts as a savings tool.

Here's How Some Kids Are Doing It Read our account of nine-year-old Peter Gustafson and 15-year-old Nichole Ostner who are saving with IRAs.

The Roth IRA is an ideal tool for kids wishing to save for a variety of goals, financial planners say. Though the contributions will be taxed, the child will likely pay a lower tax rate than he or she will have during the peak earning years. The earlier the contributions begin, the more time the balances will have to grow with the power of interest compounding.

Saving for retirement is a difficult concept for many children to grasp. But, money in a Roth IRA can also be withdrawn without taxes or penalty for qualifying expenses such as college tuition or a first home. If the child doesn't need the money and can leave it alone until retirement, the account will benefit from decades of interest compounding.

Here's the catch: The child needs to have earned income — that is, compensation from participation in a business — in order to contribute to an IRA. That doesn't include allowance, gifts or interest income.

Strategy: How Your Kids Help You Save The Taxpayer Relief Act of 1997, which created the Roth IRA, has a hidden nugget for families with kids — a $500 per child federal income tax credit. If a family qualifies for this credit, the money could be used to fund an IRA, suggests Certified Financial Planner Neil Downing, author of Maximize Your IRA.

Several mutual fund firms offer funds targeted to children. The funds have low initial investment requirements and their portfolios often include companies whose names children will recognize.

As a parent, it can be tough to set up an IRA for a minor, notes Certified Financial Planner Dee Lee, author of Let's Talk Money and The Complete Idiot's Guide to 401(k) Plans. "Many financial institutions don't want to deal with minors," she said, in part because of the custodial paperwork required for these accounts.

She recommends that parents carefully track the child's earnings and file a tax return documenting the earnings, even if they fall short of the reporting threshold.

The last thing you want to have happen is that the child is audited and the account disqualified. "I wouldn't want to give a kid that kind of lesson," says Lee.

Spousal IRAs

Compared with the last generation, many more American families now are two-income households. But, a fair number of families still have only one wage earner.

"If someone walked in the door looking for advice (on what to save in), I would recommend they use a Roth." — Mari Adams, a certified financial planner in Boca Raton, Fla.

The 1997 tax bill amended the IRA rules to increase contribution limits for stay-at-home spouses without earned income. The law had two key elements that have spurred interest in spousal IRAs. First, the annual contribution limit was raised to $2,000 from $250. Second, the law made it possible for the stay-at-home spouse to deduct his or her contribution even if the working spouse could not.

If the employed spouse is participating in a qualified retirement plan at work and earns more than $62,000 in annual salary in 2000, he or she is not allowed to make a tax-deductible contribution to an IRA. However, the nonworking spouse can make a deductible IRA contribution providing the couple is filing a joint tax return and has adjusted gross income less than $150,000.

For more on spousal IRA rules, read Spousal IRAs: Empowering the Single-income Family.

Automatic Rollover

One factor likely to boost IRA ownership over the next few years is this summer's IRS ruling that will allow employers to automatically open an IRA for former employees who leave a 401(k) balance with less than $5,000 and don't roll it over or take the cash within a certain amount of time.

Related Reading Peter's Roth IRA Young Savers Learn Valuable Money Lessons with Roth IRAs Avoid Expensive Mistakes When Making IRA Beneficiary, Distribution Choices

Participants with balances of $5,000 or more, by law, are entitled to leave their money in the former employer's plan.

The ruling is unclear as to how the money will be invested in the IRA. 

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.