Roth IRAs: a good deal just got better.

• Author: Moore, Philip E.

One of the most pressing problems in the U.S. today is the fate of the Social Security system. Many workers are concerned that it will be bankrupt when they reach retirement age. An alternative is for a taxpayer to provide for his own retirement. However, it is difficult to accumulate substantial sums for retirement during working years and even if savings are possible, they are greatly diminished by taxation.

Financial vehicles, such as traditional IRAs, simplified employee pensions (SEPs), savings incentive match plans for employees (SIMPLEs), and Keogh plans, as well as Sec. 401(k) plans, are available and offer tax deductibility to qualified taxpayers. These methods are very effective in helping taxpayers to accumulate resources to fund their retirement. Income on traditional and nondeductible IRAs, SEPs, SIMPLEs, Keoghs and Sec. 401(k) plans and other deferred accounts are taxed on withdrawal. At the taxpayer's death, if left to nonspousal beneficiaries, deferral ends and these items are fully taxable.

Withdrawal from these types of investments, even after a taxpayer reaches age 59 1/2, should be done only as a last resort. If other sources are available, they should be used before any of these deferred accounts because, if left to accumulate, the tax-deferred accounts will do so tax-free until withdrawal. If a taxpayer has nonretirement savings available, the withdrawal of these funds would not create a taxable event, because the taxpayer has already paid the tax. Given that, the taxpayer should use these funds first.

Effective for tax years beginning in 1998, Congress created a new retirement, investment, the Roth IRA, which is treated in the same manner as an IRA, except that contributions are not tax-deductible; after a five-year waiting period, withdrawals of both contributions and income are tax-free. Contributions can accumulate for an unlimited period, earning considerable income, on which nobody will ever pay tax. There are no required minimum withdrawals at age 70 1/2 as with traditional IRAs, allowing a Roth to remain intact as long as desired. In the event of a taxpayer's death, the Roth IRA will be included in his estate for estate tax purposes, but neither he nor his heirs will pay tax on it.

The rules on Roth IRAs are:

1. The maximum contribution is $2,000 per working year, increasing to $5,000 by 2008. The maximum amount that a taxpayer can contribute to a combination of the traditional and Roth IRA is an aggregate of...