A Great Name in IRAs

By Daniel Kadlec

Few politicians have branded their name as well as the Republican Senator from Delaware, William Roth. Before him, Carter Glass and Henry Steagall did all right with their Depression-era banking laws. And Eugene Keogh has a legacy with the self-employed. But the Roth IRA is in a class of its own: the most hyped investor doodad for Everyman since mutual funds. Merrill Lynch says the Roth IRA is its most visible product, hands down. Run against Roth at home, and unless your name is 401(k), you don't have a shot.

Roth acknowledges that his popularity has been boosted by his IRA legislation, which lets you sock away $2,000 a year in after-tax money that then grows tax-free. "As I walk around Wilmington," he told me, "people yell from their cars, young and old, all backgrounds, 'Hey, Bill, love your IRA!'" But what's good for Roth and for Everyman isn't necessarily good for you. The Roth, as it's known, could stand improvement. For starters, there are ridiculous income limits. Couples earning more than $160,000 a year are ineligible, and if they earn $100,000 they can't convert an old IRA to the Roth. Boohoo for the rich? Not quite. A pair of big-city schoolteachers may not be able to convert, while some millionaires can. How? Defer a bonus. Take time off. For one year, just don't earn $100,000.

Nevertheless, the overwhelming majority of Americans qualify--with no shenanigans. And for many, the Roth is a great deal. You pay no tax upon withdrawal. The old-style IRA, which allows you to put away before-tax money and pay tax upon withdrawal, remains useful. But restrictions cut most people out. Still, there's $1.3 trillion sitting in the things, thanks to years of 401(k) rollovers and initially generous IRA terms. Much of that should and will convert to new Roth accounts, and that is plainly what's behind the current Roth marketing blitz.

Don't fall for it blindly. When you convert, you must pay tax on the whole bundle. Converting makes sense if you have non-IRA funds to pay the tax and will stay in the same tax bracket or move to a higher one. It helps if you invest in stocks and have 10 years before you'll need the money. If that's you, convert this year while the taxman is running a Roth special: you get to spread the tax liability over four years. But if you're near retirement and lean toward bonds or CDs, converting may be a bad idea. Analysis by accountants Grant Thornton shows that a couple in the 28% tax bracket ('98 income between $42,350 and $102,300) will need 22 years to come out ahead, assuming some state tax, a 15% federal-tax bracket in retirement and 6% average annual returns.

Another unspoken liability is the possibility that later on a tax will be levied on a Roth's earnings. It's hardly unthinkable, though Senator Roth maintains it'll never happen because of the "political hailstorm" that would ensue. But Social Security benefits weren't taxed before the 1980s. Real estate deductions were greatly curbed in 1986. In 20 years, predicts Robert Walsh, a tax professor at Marist College, if Social Security is bankrupt, "the politicians will see this huge pot of money called the Roth, and they won't be able to leave it alone." The Roth is a good idea for many people--and it sure has worked out well for the Senator. But if the taxman comes calling two decades hence, don't say I didn't warn you.

Daniel Kadlec is TIME's Wall Street columnist. Reach him at [email protected]