What has happened to the IRA?

• Author: Lavin, David
• Position: Tax law reform

The traditional individual retirement account (IRA), one of the most popular savings vehicles available, generally allows individuals to make deductible contributions of up to $2,000 annually. Contributions are deductible if the taxpayer is not an active participant in an employer-sponsored plan or if he is covered by a plan and his modified adjusted gross income (MAGI) does not exceed certain thresholds.

The Taxpayer Relief Act of 1997 (TRA '97) enhanced the traditional IRA and created two new IRAs, the Roth IRA and the Education IRA.

The decision to use one or a combination of these accounts will depend on one's savings goals other than retirement. Understanding a client's goals and the expanded flexibility of IKAs is critical in making the appropriate choices.

Enhanced Traditional IRA

Effective Jan. 1, 1998, for individuals covered by a qualified plan, the MAGI phaseout ranges for deductible contributions gradually increase each year. This makes deductible IRA contributions available to more taxpayers. The ranges level off in 2005 for single taxpayers; for joint filers, they level off in 2007 (see Exhibit 1, above).

Exhibit 1: MAGI thresholds In 1998 By 2005 Single filers $30,000 to $40,000 $50,000 to $60,000 Joint filers $50,000 to $60,000 $80,000 to $100,000 There are two exceptions to the rule imposing a 10% penalty tax on early withdrawals prior to age 59 1/2. Penalty-free withdrawals may now be made for:

* Qualified higher education expenses for the taxpayer, spouse, child or grandchild.

* Qualified first-time home purchases up to a lifetime limit of $10,000.

While these withdrawals may be made without penalty, they are still subject to ordinary income taxes.

Also, beginning in 1998, many individuals previously unable to make a deductible IRA contribution because their spouses participated in an employer-sponsored plan became eligible to do so. Under pre-TRA '97 law, if either spouse was covered under an employer-sponsored retirement plan, both spouses were deemed covered, effectively limiting the deductibility of IRA contributions of both spouses. Now, if one spouse is a participant in a qualified plan and the other is not, the non-participant spouse may make a fully deductible IRA contribution. Eligibility for this special rule is phased out if the couple's MAGI is between $150,000 and $160,000.

The Roth IRA

Effective Jan. 1,1998, the TRA '97 created a new, nondeductible IRA. Named the Roth IRA, this new IRA generally allows the...