Spell Tax-Free Saving R-O-T-H

The ads blare on the radio, bombard you on TV, and nudge you in print.

And they want you to remember one word - Roth.

The Roth individual retirement account (IRA) is the hottest new financial product since the 401(k), the voluntary work-based retirement plan that has won over millions of investors since 1981.

Last year, Congress added the Roth to the traditional IRA arsenal, and mutual funds, brokerages, and banks have jumped all over it this tax season.

That's partly because it gives them another product to sell you, but also because it has genuine appeal.

Here's the key attraction: You pay taxes on income that you put into the account, but from then on it's tax free, even when you withdraw the money in retirement. That's different from traditional IRAs, where money grows tax-free but is taxed when you remove it. (For details on IRA differences, see Page B3).

But don't be fooled by the hype. Although tax season is upon us, there's plenty of time to decide if a Roth rings true - either to open one or convert an existing IRA. You have until April 15, 1999 to make the choice and still receive all the tax benefits for 1998.

The name comes from Sen. William Roth (R) of Delaware, who pushed it through Congress last year. And especially for younger generations, it offers better tax shelter than ever for retirement savings.

"The Roth IRA is wonderful, and anyone who does not avail themselves of it is losing out in an big way," says Pat Mullin, a tax adviser at Deloitte & Touche LLP in Cleveland.

Such unqualified praise hasn't been heard for IRAs lately. In the 1980s, the spotlight gradually shifted to 401(k)s.

They have a big advantage of their own: Employers often match your contributions when you set aside a portion of your salary for retirement.

Financial advisers generally urge full use of such matching. But, they add, people who save beyond that level may find it advantageous to open a Roth account before boosting 401(k) savings. It depends on factors such as age and tax bracket.

Another plus for IRAs, compared with 401(k)s: Depending on where you open the account, they may also give you more options for investing: stocks, bonds, and more mutual funds.

Congress sees Americans saving $20 billion in taxes during the next decade, thanks to the Roth and a loosening of restrictions for deductible IRAs.

In the process, IRAs may regain some respect. The portion of households investing in them has shrunk since 1986 from 30 percent to just 6 percent, according to Charles Schwab Corp.

Despite all the hype, "reception of the Roth has been lukewarm at best," says Charles Myrick, a Washington tax adviser.

The slow start stems from the popularity of 401(k)s and the complexity of IRAs.

But help is readily at hand - in scads. Brokerages and mutual funds are falling all over each other to offer free advice.

Perhaps the easiest starting point is a worksheet on the Internet (see story, right).

One especially tricky choice is whether Americans should convert the $1.3 trillion they hold in IRAs into Roth accounts.

If you convert, you immediately owe taxes on all earnings and deductible contributions in your current IRA. (If you switch in 1998, the tax burden can be spread over four years.)

Also, conversion is impossible if your income is more than $100,000 and unappealing if you want to tap into the money within five years.

And it may not make sense if you would have to use IRA money, or sell investments at big capital gains, to pay the taxes due.

So keep the Roth's wrinkles, as well as its strengths, in mind.

One example: While holders of traditional IRAs must begin withdrawing funds at age 70-1/2, money can stay in a Roth indefinitely. This makes it ideal for estate planning. Funds go to heirs without a dent from income tax but still face estate taxes.

Even if conversion does not make sense, opening a Roth alongside another IRA or retirement account might.

"Outside of the costs of conversion, the Roth IRA is an excellent investment vehicle," says Thomas Cunningham, a tax adviser in Washington.

Note to Readers

A story on consumer spending and the economy will run next Monday, not today (as promised last week).

Four IRA Flavors

Individual retirement accounts permit tax-sheltered savings for retirement, college, or up to $10,000 of a first home. You're allowed more than one IRA; total retirement contributions can't exceed $2,000 per person a year.

Traditional

Who: Anyone up to age 70-1/2. Eligibility is phased out above $30,000 ($50,000 for couples) adjusted gross income (AGI) if you participate in an employer-sponsored retirement plan, such as a 401(k). If only your spouse is in an employer plan, your eligibility is phased out above $150,000.

How much: $2,000/year.

Taxes: Contributions are not taxed but withdrawals are.

Withdrawals: 10 percent penalty before age 59-1/2, unless for college or a first home. Minimum pullouts required at age 70-1/2.

Advantages: Immediate tax deduction for contributions.

Traditional nondeductible Who: Anyone up to age 70-1/2.

How much: $2,000.

Taxes: Contributions are taxed. Earnings are not until withdrawn.

Withdrawals: 10 percent penalty before age 59-1/2, unless for college or a first home. Man-datory minimums at age 70-1/2.

Advantages: Tax-sheltered savings growth for people whose income is too high for other IRAs.

Roth

Who: Anyone with earned income, up to limits below.

Who can convert: Singles or couples, AGI below $100,000.

How much: $2,000 (phased reductions above $95,000 AGI for singles, $150,000 couples).

Taxes: Contributions taxed, withdrawals tax-free.

Withdrawals: Penalty-free after 59-1/2. 10 percent penalty on earnings withdrawn before that unless for college or first home. Money converted from a traditional IRA must stay in the Roth account five years.

Advantages: No taxes on earnings, no mandatory withdrawals, no age limit on contributions.

Education

Who: Anyone, on behalf of a minor, with AGI below $150,000 ($95,000 for singles).

How much: $500 (Congress may boost to $2,000) until beneficiary turns 18.

Taxes: Contributions are taxed. Money grows and is withdrawn tax free.

Withdrawals: Not taxed if used to pay for higher education before beneficiary turns 30.

Advantages: Tax-sheltered college savings.