GETTING PERSONAL:Bush Plan Raises IRA Transfer Questions
03 Feb 07:30
By Kaja Whitehouse
A Dow Jones Newswires Column
(This report was originally published late Friday.)
NEW YORK (Dow Jones)--The Bush administration proposal to revamp the way
people save for retirement offers investors lots of treats. But it may be
expensive for people who have already saved a bundle in old plans to make the
leap.
At issue is a White House proposal released Friday to create a new individual
retirement arrangement, or IRA, which is a popular, private retirement savings
vehicle. It will be called a retirement savings account, or RSA, and will
replace what is now the ROTH IRA, but with higher contribution limits and made
available to people of all income levels. It will also replace, to some extent,
the traditional IRA, which is currently the IRA that carries the largest
assets.
The problem comes for people who have already saved a lot of money through a
traditional IRA. If they want to convert to the new RSA, they could face a
heavy tax bite because they will be charged ordinary income taxes on the funds
they convert.
The Bush plan will allow people to spread that tax bite over four years if
the traditional IRA is converted to the RSA before 2004. But some people may
not want to convert before 2004 because they feel that tax rates may continue
to decline - in which case the tax bill will lessen - or that stock market
prices will continue to decline - in which case they will be taxed on an
investment that drops in value.
"You want to make sure you pay taxes on something that's likely to
appreciate," said Steve Lockwood, co-author of "The Individual Retirement
Account Answer Book."
The last time large groups of investors made the switch from traditional IRAs
to a tax-free savings account like the RSA was in 1998 and 1999, when the ROTH
IRA was first introduced. It resulted in a lot of angry investors who paid a
hefty tax bill to transfer inflated assets only to see them drop when the stock
market fell in 2000.
"Given that some got burned a few years ago converting, maybe there will be
some shyness in doing this again," Nick Kaster, senior pension and IRA analyst
at tax consultant firm CCH Inc. in Riverwoods, Ill.
Overall, however, tax and retirement experts recommend that anyone who can
afford to make the jump from a traditional IRA to the RSA do it.
The RSA has many more benefits than the traditional IRA because it allows
money to be withdrawn at any time so investors can, theoretically, leave
everything to their heirs. With a traditional IRA, people have to start taking
money out at age 70.5, whether they need the income or not. Additionally, heirs
will avoid paying income taxes on RSA assets, but they will be charged income
taxes on traditional IRA bequests.
"There may be people who don't want to covert because they don't want to pay
the tax bill, but I would encourage people to do it," said Ed Slott, a
certified public accountant and IRA expert in Rockville Centre, NY.
Experts offer a few tips on converting, like paying the tax bill with
after-tax dollars, and choosing RSA investments wisely.
"Most of the economic analysis of ROTH conversions says it becomes a good
deal when you pay the conversion tax out of other funds," said Stuart Lewis,
head of tax section for Silverstein & Mullens, a law firm in Washington D.C.
Paying a $30,000 tax bill from a $100,000 investment leaves the investor with
that much less to grow tax-free, he said.
People should also carefully choose their investments, especially if they
have little faith that recent stock markets drops will soon turn the other way.
What happened following the conversion of 1998 and 1990 "could happen again,"
said Martin Nissenbaum, national director of retirement planning and taxation
at Ernst & Young in New York. "That, of course, is an investment decision
people have to make," he added.
Of course, if stock markets have reached their bottom, investors who convert
would be paying a lower tax bill for assets that climb. "Now is a great time to
convert," said Slott. "You're getting a half-off sale right now."
It makes little sense to convert, however, for people now in a top income tax
bracket if they expect to be in a much lower tax bracket when they retire. For
example, converting at a 28% bracket would mean paying $28,000 on a $100,000
investment. But that money would be wasted for people who expect to drop to a
10% tax bracket when they retire.
Under the Bush proposal, people would not be forced to convert, but noone may
make additional contributions to traditional IRAs after 2003. The only new
contributions that will be allowed will be for investors who roll over assets
from an employer plan, like a 401(k).
Of course, the 401(k) will no longer exist under the new plan because most
employer-sponsored retirement plans will fall under the same rules and be known
as the employer retirement savings account, or ERSA.
-Kaja Whitehouse, Dow Jones Newswires, 201-938-2243,
kaja.whitehouse@dowjones.com
(END) Dow Jones Newswires
02-03-03 0730ET |
