Many Factors in Decision to Convert IRA to Roth

By Jane Bryant Quinn

NEW YORK -- I've been flooded with letters about the new Roth Individual Retirement Account.  A typical question comes from a reader in White Lake, Mich.

"I have $90,000 in a regular Individual Retirement Account," she writes.  "If I keep it, I'll owe taxes when I take the money out. If I convert it to a Roth, I'll lose about one-third of the money in taxes and commissions, but any growth afterward is tax free.  Which is best?"

Unfortunately, there's no single answer.  Some people should convert, others shouldn't.  But there are some general rules of thumb.

First, a quick definition of a Roth.

It's for workers with earnings.  If you're starting one from scratch, you can deposit up to $2,000 a year ($4,000 for a married couple).  You qualify for the full contribution if you're single with an adjusted gross income up to $95,000, or a married couple up to $150,000.  Above those income levels, contributions rapidly phase out.

You don't get a tax deduction for the money you put in.  But the earnings you accumulate can be taken tax free, as long as you hold the account for at least five years and are (1) at least 59 1/2, (2) disabled or (3) taking up to $10,000 in earnings to buy a first home.

You are never required to take the money out.  You can leave it to heirs income-tax free, as long as you hold it at least five years (although you'll owe estate taxes if you're wealthy enough).

You may be able to convert a current IRA into a Roth.  You qualify for a conversion if your adjusted gross income is $100,000 or less, married or single.

But the rollover isn't tax free.  The money you convert has to be reported as taxable income.  (Your taxable IRA income, by the way, doesn't count toward the $100,000 limit.)

If you switch to a Roth in 1998, you can spread the income, and thus the tax, over the next four years.  If you wait until 1999 or later, your tax will be due all at once.

Should you convert? Here are the general rules:

* Don't convert, if you'll have to pay the income tax out of your IRA funds.  It's unlikely that you will recover that loss.

* Do consider converting, if you can pay the income taxes out of your earnings or other savings.  The tax-free growth might yield more in the end.

* Don't convert, if you will drop to a much lower bracket in retirement.  This rule would cover someone in the 28 percent bracket who expects to retire in the 15 percent bracket.  It's better to wait and pay the tax when your bracket is low.

* But do consider converting, if your tax bracket will rise in retirement, remain the same or fall just a little bit.  For example, a conversion might be smart if your bracket goes from 31 percent down to 28 percent and you hold at least seven or eight years, according to The Vanguard Group of mutual funds.

* Do convert, if you won't need this money in old age, or won't need much of it.  You don't have to start taking out the money at age 70 1/2, as you would with a regular IRA.  Your Roth can be left to your heirs, income-tax free.

Still, every case is individual.  "You shouldn't decide without making specific assumptions and running the numbers," says Shelley Freeman, senior vice president of Wells Fargo Bank in San Francisco.

Whoever proposes a Roth to you should have a computer program that compares keeping your current IRA with switching to a Roth.  Among other things, it should consider your age, your current and expected tax brackets and your projected investment return.

You should also ask an accountant or tax preparer to test your tax return with and without a Roth.  You want answers to such questions as:

* When you convert, will the IRA income you have to report push you into a higher bracket, make you ineligible for any tax credits or make your Social Security income taxable?

* Do you have both deductible and nondeductible IRAs? You can't convert just the nondeductible ones, where the rollover tax may be small, says Vanguard's Joel Dickson.  Conversions are treated as coming proportionately from every IRA you own.

* Can you get along without touching your Roth contribution for the first five years? Congress is expected to penalize people who convert and take out money within this period of time.

As you see, not an easy decision -- but one you have to think about.

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