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Rolling To Roth

An optimist can pull something good out of a situation even as bad as 1998 cattle prices. This time it can be the Roth IRA opportunity. If you have IRA, Keogh or SEP retirement investments, rolling some or all of them to a Roth IRA before year end is worth studying for long-term tax savings.Let's see how a Roth IRA rollover might fit especially well this year.Traditionally, IRA, Keogh and SEPs have

An optimist can pull something good out of a situation even as bad as 1998 cattle prices. This time it can be the Roth IRA opportunity. If you have IRA, Keogh or SEP retirement investments, rolling some or all of them to a Roth IRA before year end is worth studying for long-term tax savings.

Let's see how a Roth IRA rollover might fit especially well this year.

Traditionally, IRA, Keogh and SEPs have been tax deductible when you invested the money for your retirement. Earnings were also tax deferred.

Therefore, when you start taking the money out of a traditional plan during your retirement years, you would pay income tax on all of it.

Now, along comes the Roth IRA that allows you to roll your current tax-sheltered, retirement money and pay some tax now, but never have to pay any more tax on it in the future.

The Roth IRA is named after Senator William Roth, Jr., chairman of the Senate Finance Committee. There are really only two rules:

* Your adjusted gross income for the year you roll can't be more than $100,000. That applies to both single and joint return filers.

* Keoghs have to be rolled over to an IRA before they can be rolled into a Roth - just an extra paperwork step.

"You don't even have to move the money to roll it," says Paul Christoffers, a retirement and benefits planning specialist in Ankeny, IA. "You can leave it in exactly the same investment it has been in. Or, you may want to look at some new investment strategies."

Rolling isn't, of course, tax free. If you decide to roll $20,000 of your IRA investments to a Roth IRA, you have to report that $20,000 as income on your 1998 tax return. If you pay federal income tax on that at 15%, that will cost you $3,000. Plus, depending on your state, there might be state income tax. Maybe that's another $1,000 for a $4,000 total.

"Actually, you can spread that income over four years and pay the tax at a slower pace if you do the Roth roll in 1998," says Duane Murken, an Iowa Farm Business Association consultant at Swisher, IA.

"You can still roll to the Roth in future years," he says. "But there's no spreading of the income. Any amount you roll after 1998 will be reported as income on that year's tax return."

Once you pay the tax, however, you will never pay tax on that $20,000 in our example again. And, you won't pay tax on any of the growth from that $20,000.

Advisors suggest that you pay the tax from money outside your retirement plan so you have the full amount ($20,000 in our example) left to grow tax free.

But any way you shake it, you lose the use of the tax paid ($4,000 in this example). It's not available to earn interest. You paid the tax earlier than you would have to and that goes against the grain of most farmers and income tax advisors. That's the disadvantage of rolling to a Roth.

However, rolling part or even all of the money you have in IRAs before year end may be a smart move. That may be true even if your 1998 income is relatively good. It depends on your situation.

Low-Income Year Strategy What if your income is really low or you have a loss on your tax return for 1998?

That can be the opportunity to really harvest the benefits of a rollover to a Roth, says Murken.

Let's use an example where you add up all the income and losses (assume you have a farm loss for 1998) that you will list on the front page of Form 1040 of your 1998 tax return and you come up with exactly zero.

Now, add in $20,000 of rollover to a Roth. Your income becomes $20,000. But, you're not done yet. You can deduct some things from that. You have a standard deduction of $7,100 if you're filing a joint return.

Each person (you, your spouse and each dependent child) gets a $2,700 personal exemption. Those add up to $12,500 ($7,100 + $2,700 + $2,700) assuming you have no dependent children to claim. Subtract that from the $20,000 total income and your taxable income would become only $7,500. At the 15% federal rate, that would trigger only $1,125 of federal tax. That's only 5.625% of the $20,000 rollover. Even if you have to pay some state tax, that's going to be a bargain since you will probably be in a higher tax bracket during retirement. Plus, future growth will be tax free.

"You may want to roll enough into a Roth to push your taxable income up to the top of the 15 percent tax rate," says Murken. "That taxable amount is $42,350 in 1998 for a married couple filing a joint return." It may even pencil out to roll into a Roth when some of the dollars will be taxed beyond the 15% federal rate, of course.

In cases like our example, where you have low income and a low tax rate, you may not want to use the four-year averaging option, says Murken. You may prefer to roll some IRAs to the Roth IRA in years when your income is low and do nothing in high-income years.

If your income is too low to use all your personal deductions such as the health insurance deduction, your standard deduction and your personal exemptions, work with your advisors to see if and how much of your IRA, SEP and Keogh investments you should roll to a Roth IRA. If you don't use those deductions this year, they are lost forever. Study it well ahead of year end to give you time to make the changes.

Is Roth Better? It's really hard to run the numbers on a rollover because it's hard to compare when you're looking at some dollars that are taxable and some that aren't. You're also looking at different lengths of time the money will stay in and come out.

When all things aren't equal, it's like comparing apples to oranges and the answer isn't going to be completely clear.

Christoffers uses a farm example as a general rule: "Would you rather pay tax on the kernels you plant (a small amount) or on the kernels you harvest?" The Roth rollover may let you pay a small amount of tax now rather than a lot later.

To compare this to a traditional IRA, let's say the IRA is $10,000 now and is kept an IRA. If you leave it for another 15 years and earn 7% annual interest compounded, it will grow to $27,590. If you could take it all out then and pay 15% tax, you would have $23,450 after tax.

But what if you pay 15% tax on it now and roll it to a Roth that will never be taxed again. Your $8,500 left after paying tax would grow to exactly the same $23,450 in 15 years at 7% and there would be no more tax to pay.

However, if you pay tax at 15% now and 25% later, you would only have about $20,690 if you leave it as a traditional IRA versus $23,450 for a Roth IRA.

Paying tax out of other funds and leaving the full $10,000 to grow tax free rather than $8,500 would also show an advantage for the rollover.

With even a 15% tax bracket, $1,500 earning 7% would grow to about $3,570 after tax in 15 years. But $1,500 growing tax free would grow to nearly $4,140. Everything else being equal, there's always a huge advantage to money growing tax free.

Decision Making Guidelines As you can see, accurate projections of your advantage or disadvantage of rolling to a Roth are difficult. The best advice is to work with an advisor such as your income tax consultant or accountant. But, there are also some general guidelines provided by Murken and Christoffers.

The longer you can let your account grow until you start drawing from it, the greater the advantage of the Roth. Therefore, younger people will generally benefit more from rolling to the Roth than will older people. If you're older, still consider it; but study it closer.

The higher the expected return from your IRA investments, the more you will gain from rolling to a Roth.

The more you expect your tax bracket to go up between now and when you will need to take the money out, the better your return will be from rolling to a Roth. However, if you expect your tax bracket to be lower during retirement than now, you better pencil real hard before you roll.

With the Roth, there is no rule that you have to start withdrawing money at age 70 like with the traditional IRA - or at any other age. Therefore, if you want more flexibility on withdrawals, consider the Roth.

Another situation where the Roth rollover looks good is if you never plan to use some of that retirement fund money. You figure it will still be there for your children to inherit. If you don't roll it to the Roth, your children will have to pay income tax on it when they receive it. If you do roll it, they won't have to pay any income tax on it.

Therefore, if the tax rate now is reasonable, roll at least the amount you never plan to use.