Inertia Plagues the Roth IRA 18 Months After Its Debut
Roth individual retirement accounts were unveiled on Jan. 1, 1998, with considerable fanfare.
Investment advisors, tax preparers, financial writers and others touted the new IRAs as a great way to build up a nest egg, tax-free. Their value is greatest to young adults, but even working seniors can sock away money in Roths. They seemed to offer something for almost everybody.
Yet now, 18 months later, the marching bands have gone, the confetti has been swept up and most eligible Americans never took the plunge. Many others seem to be having second thoughts.
“A fair amount of inertia has set in,” said Esther Berger of Berger & Associates, an investment advisory firm in Beverly Hills. “People don’t like change.”
Ed Slott, a certified public accountant in Rockville Centre, N.Y., who publishes an IRA newsletter, says the idea behind Roths was a good one. But he thinks Congress may have let the new IRAs out of the box too quickly, with the result that several rules had to be tweaked.
“A lot of the resulting confusion seems to have driven people away,” Slott said.
A first-quarter survey of more than 750 investors by American Century Investments of Kansas City, Mo., found that only 25% planned to make a Roth contribution this year. That compared with 60% of the respondents who said they intended to sink money into traditional IRAs, and 5% who planned to fund both.
Another survey of 1,000 people, by Fidelity Investments in Boston, determined that investors last year made almost three times as many contributions to traditional tax-deductible IRAs as to Roths.
“The results suggest that many Americans may still not be aware of the relative benefits of the Roth and may be focusing on immediate tax savings now,” said Stephen Mitchell, a Fidelity senior vice president in Boston. “Roths have not supplanted traditional IRAs.”
The main lure of a traditional IRA is the ability to deduct the amount you invest--up to $2,000 per person annually--assuming you lack a retirement plan at work or meet certain income thresholds. In retirement, money withdrawn from traditional IRAs triggers ordinary income taxes.
By contrast, investors receive no such deduction when opening a Roth, for which the yearly investment limit also is $2,000. Yet they stand to realize a much more substantial back-end benefit, because no taxes apply on Roth withdrawals, provided you maintain the account for at least five years and have reached age 59 1/2. Compared directly with a traditional IRA, the Roth would be a better deal if tax rates are relatively high in the future, but could be a worse deal if tax rates are low.
But more importantly, Roths are available to millions of Americans who cannot deduct a traditional IRA.
“I’m surprised that Roths even exist,” said Robert Kailes, a certified public accountant and certified financial planner in Playa del Rey. “Where can you get a better deal, especially if you’re young?”
Kailes says he has waged a personal crusade to encourage clients to open Roth IRAs. When he encounters a fence-sitter, Kailes points out that those $2,000 yearly Roth contributions can be withdrawn at any time, free of both taxes and penalties. Taxes and penalties would apply only on investment earnings withdrawn before age 59 1/2 or within the five-year minimum holding period.
Although the experts often differ on what kinds of investments should be in which accounts, advisor Berger senses that many investors are too conservative with their Roth holdings. Because earnings escape taxation in these accounts, she says there’s a big incentive to use growth investments: high-yield bonds, stocks, stock mutual funds.
“If you’re under age 60, I’d keep 60% to 70% in equities,” Berger said. “It’s amazing to me how conservative some people are.”
Although the rationale behind Roth IRAs is simple--no taxes on withdrawals--the message does get obscured by details. It doesn’t help that Roth rules are frequently different than for traditional IRAs.
For example, Roths are open only to investors with income below certain limits. You can sock away a full $2,000 a year, provided you have adjusted gross income below $95,000 for singles and $150,000 for married couples filing jointly. You can invest a partial amount with an AGI between $95,000 and $110,000 if single, and between $150,000 and $160,000 if married.
More confusing still, traditional IRAs underwent a make-over around the same time the Roth was introduced. Among the new wrinkles, Congress added a rule that makes it easier to tap a traditional IRA before age 59 1/2. You can avoid a penalty by using the money to meet higher-education costs or to buy a first home. Roths have their own set of rules for circumventing early-withdrawal penalties.
The good news, says Fidelity’s Mitchell, is that the media scrutiny given to Roths last year seems to have revitalized interest in traditional IRAs.
“Unfortunately, what started as a simple concept 25 years ago--the IRA--has become very complicated,” he said.
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Russ Wiles is a regular contributor to The Times. He can be reached at russ.wiles@pni.com.
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Evaluating Roths
Considerations when deciding whether to open a Roth IRA:
The Good
* If you follow the rules, you never have to pay taxes on money withdrawn from a Roth.
* Almost anyone meeting the income limits can open a Roth, including senior citizens or children with part-time jobs.
* You don’t have to start withdrawing from a Roth after you reach 701/2.
* An employed person can open a Roth for a nonworking spouse; thus, a couple can sock away $4,000 a year.
* You can invest in a Roth even if you actively participate in a workplace retirement plan.
* You can withdraw the amount contributed to a Roth, as opposed to the earnings, at any time without incurring taxes or penalties.
* Because you don’t have to withdraw funds at 701/2, the Roth has estate-planning advantages.
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The Bad
* Roths are open only to single people with adjusted gross income below $110,000 and to married couples with AGI below $160,000. You can invest the full $2,000 only with income below $95,000 (singles) or $150,000 (couples).
* You can’t put more than $2,000 a year into a Roth.
* You can’t hold collectibles such as artwork, coins or stamps in a Roth, except for certain U.S. gold and silver coins.
* Investment earnings are taxable and subject to a 10% penalty if withdrawn within fewer than five years and before age 591/2.
* Excess contributions to a Roth are subject to a 6% penalty.
* After the investor’s death, a Roth will eventually be subject to minimum-withdrawal rules; failure to heed the rules could trigger a 50% tax for beneficiaries.
Sources: CCH Inc., Times research
