Tuesday, December 29, 1998

Deadline nears for converting IRAs to Roth IRAs

By SCOTT SCHOLTEN

Staff Writer

As the Dec. 31 deadline for converting regular Individual Retirement Accounts to Roth IRAs nears, Abilene financial advisors aren't seeing a flood of paperwork from clients wanting to get in on what is widely considered an unusually generous tax break from Congress.

The main reason reaction has been so tepid is that Roth IRA conversion rules are so restrictive. People who can fall within the plan's income restrictions typically cannot afford financial advisors to guide them through the complex matter, said Ray Fergeson, a certified public accountant with Abilene's Condley & Co. LLP.

Roth IRAs differ from standard IRAs in that regular IRAs may be eligible for tax deductions in the year they are made while Roth IRA contributions never are.

But earnings and withdrawals from a Roth IRA (if investors keep the Roth IRA for a minimum of five years) are never subject to income taxes, according to today's tax code.

Standard IRAs may be deductable in whole or in part, while regular income taxes apply to non-principal portions at the time of withdrawal.

Yet, in order to convert standard IRAs to Roth IRAs, investors have to earn less than $95,000 annually, which narrows the pool of people who can comply with the rules and take advantage of the plan, Fergeson said.

"Most people that do qualify probably don't seek professional advice," said Fergeson, who has executed only one standard-to-Roth IRA conversion since the new law took effect in January.

Fewer than one-third of Jerry Love's qualifying clients are converting to Roth IRAs, said the Abilene CPA with Davis Kinard & Co. PC.

Conversion before the Dec. 31 deadline means that though investors will have to pay taxes on the value of their IRAs as taxable income, they can spread the income over four years, possibly lowering their tax bracket, and making the year's tax bill affordable, Love said.

Congress created the four-year pay off plan in order to make the plan available to people considered middle class.

Moreover, if an IRA is large enough, investors may not have on-hand funds to cover the tax liability generated by the conversion, whether done in one fell swoop or, if the account is big enough, spread over four years, Love said.

If that's the case, people may have to dip into the IRA itself, which triggers an additional 10 percent penalty owed the IRS for pulling money out of the IRA prematurely, Love said.

With the income stipulations and tax liabilities on people whose main source of wealth is bound up in IRA-sheltered securities, about one-third of Susan Stroud's clients have converted to Roth IRAs, said the Abilene stock broker with A.G. Edwards.

Most people are put off by all the rules when they call to find out about it, Stroud said.

Since the taxes can be significant, it's mostly young people with relatively meager IRAs that are able to afford the taxes associated with the conversion, Stroud said.

Another perk of the Roth IRA is people can dip into the accounts and use the money for higher education or a house without penalty, Stroud said.

Because the rules are complex, all sources encourage people thinking about the conversion to consult an accountant to help them calculate if the move is feasible.

However, Love said, just because the Dec. 31 deadline looms to convert the whole IRA into a Roth and be able to spread the taxes over four years, that doesn't mean people cannot convert regular IRAs to Roth IRAs at a later time.

"If you didn't qualify this year or felt you couldn't afford to do it this year, in some later year you could do a partial conversion," Love said. That is, as long as one converts only as much as he can pay taxes on, Love said.

"It's not like if you don't do it this week you aren't ever going to be able to do it," Love said.

And Love is careful to point out that all this is subject to U.S. tax law as of 1998. Though Congress typically grandfathers in such tax breaks or gives investors a chance to convert assets, there are no guarantees on future tax code, Love said.

"What Congress gives, Congress can take away," he said.

Scott Scholten may be contacted at (915) 676-6737, or scholtens@abinews.com.