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Roth IRAs - 1998 changes.

Not content with the initial Roth Individual Retirement Account provisions enacted in the Taxpayer Relief Act of 1997, Congress has significantly fine tuned the rules for this astoundingly popular tax-saving device. These new rules - contained in new tax legislation signed by President Clinton this past July 22nd - can be critical to a decision on whether to open up a Roth IRA, or whether to continue to maintain one. Some of these Roth IRA changes present new opportunities, while others can affect previously made planning assumptions. In addition, the Treasury Department - even more recently - has released comprehensive rules and regulations on Roth IRAs, which will require many taxpayers to make further adjustments to their tax planning.

The latest series of legislative changes to Roth IRA rules are part of the sweeping new IRS Restructuring and Reform Act of 1998, which addresses many non-IRS-related tax issues. These changes make some Roth IRA rules more difficult to avoid and, in turn, require a more complex set of computations. However, they also ease up on some of the other rules originally set forth in last year's Taxpayer Relief Act of 1997, responding to complaints by experts and constituents that certain rules were too restrictive.

The most significant 1998 legislative changes to Roth IRAs - both pro and con - include the following:

* New withdrawal rules for 1998 conversions. Most qualifying taxpayers find that converting a regular IRA into a Roth IRA makes the most sense in 1998, when a special income-averaging tax break allows income from 1998 conversions to be spread over 4 years, from 1998 through 2001. One loophole that taxpayers quickly found was that, through a technical misstep in the original law, they could arrange withdrawals of Roth converted funds within the 4-year spread period without incurring any penalty. The 1998 law repeals this loophole, retroactively to January 1, 1998, but does so in a way that may still be advantageous for some taxpayers. Under, the new rules, income inclusion is accelerated for any amounts withdrawn before 2001, rather than requiring any retroactive computation of tax liability. In addition, new ordering rules favorably determine which amounts are withdrawn for tax purposes when a Roth IRA contains both conversion and contributory amounts or earnings, or conversion amounts from different years. Those who previously have been afraid to convert to Roth IRAs because of harsh withdrawal rules should now reconsider the possibilities.

* Election not to income average. The 1998 law allows taxpayers who are converting to a Roth IRA in 1998 to elect whether or not to recognize all income in the year of conversion or recognize it ratably over four years. This new option may prove a windfall to certain taxpayers. Correction of erroneous conversions. Under the new 1998 law, taxpayers now have until the due date of their returns, including extensions, to change their minds about any Roth IRA conversions that take place during the tax year. This rule particularly helps taxpayers who convert to a Roth IRA early in the year, only to find they exceed the $100,000 adjusted gross income level at year's end. It can also help those who change their retirement assumption during the year.

* Benefits at death. Those who convert to a Roth IRA in 1998 no longer need to worry that their premature death might cause high tax liability for their spouse. Under the 1998 law, a surviving spouse who is the beneficiary of a 1998 Roth conversion IRA, can elect to continue to defer income over the remainder of the 4-year spread period.

* Changes to $100,000 AGI limit. A Roth conversion cannot take place if a taxpayer's adjusted gross income exceeds $100,000 in the year of conversion. The new 1998 law changes the underlying tax computations for many taxpayers. Principally, AGI and all AGI-based phaseouts for this purpose are to be determined without taking into account the conversion amount; and, beginning by 2005, the definition of AGI will exclude minimum required retirement distributions.

In addition to the 1998 legislation, Roth IRAs have received further governing rules through Treasury Department regulations that were released on August 31st. These regulations are extensive and represent the official IRS interpretation of the Roth IRA provisions enacted by Congress in both the 1997 and 1998 tax laws. In filling in the details that Congress did not provide, the Treasury Department regulations provide helpful (and some mandatory) rules which include: Restrictions of contributions. The new regulations explain how contributions to regular IRAs and Roth IRAs can dovetail, and when they conflict. They also clarify that a taxpayer may change his or her mind on a Roth IRA contribution as late as the due date for filing the income tax return for the year involved.

* Roth conversion rules. The new regulations add much-needed detail to the rules for making a proper Roth IRA conversion in 1998, as well as in future years. One aspect of the rules of immediate impact is that the regulations peg the year in which a rollover conversion takes place to the year funds are withdrawn from a traditional IRA, not when they are deposited into the Roth IRA. This allows Roth IRA rollovers that straddle year-end 1998 to take advantage of the more favorable 1998 tax year income recognition rules, even if Roth IRA deposits are not made until early 1999.

* Roth recharacterization rules. Under rules that were initially drafted to cover only those who mistakenly convert to a Roth IRA, the proposed regulations can also be applied in full to Roth IRA accounts that have decreased in value during the tax year of conversion. As a result, a taxpayer who would be paying income taxes on a Roth IRA conversion at a value-at-conversion that is much higher than its existing value should consider reconverting back into a traditional IRA, tax free. The IRS and tax practitioners are also grappling with the question of whether such "recharacterized" funds can thereafter be reconverted back into a Roth IRA, therefore potentially savings IRA owners significant income tax liability.

* Distribution priorities. One important advantage of a Roth IRA is the ability to withdraw amounts tax free in "qualified distribution" situations. In planning multiple-year Roth IRA contributions, the new regulations allow favorable computation of a critical 5-year waiting period rule for withdrawals. They also give taxpayers precise guidelines - using complex aggregation and ordering rules - on how much of a Roth IRA withdrawal will be taxed, and under what circumstances
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Title Annotation:Roth Individual Retirement Accounts
Publication:The National Public Accountant
Date:Jan 1, 1999
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