by Archie M. Richards, Jr.
June 26, 2006

IRAs are a bad lot. They're loopholes to offset excessively high income tax rates. But the best of the bad lot is the Roth IRA.

Regular, traditional IRAs do offer tax deductions. But withdrawals are required, and they're taxed.

With Roth IRAs, earned income is taxed before it goes into the Roth. But withdrawals are never required, and they're generally not taxed.

No matter what your age or whether you're covered by a retirement plan at work, you may contribute up to $4,000 of earned income each year to a Roth IRA. (Those over 50 can beef this up to $5,000.)

Contributions are phased out, however, if your Modified Adjusted Gross Income exceeds $150,000 for joint taxpayers and $95,000 for single taxpayers. (Adjusted Gross Income is the number at the bottom of page 1 of Form 1040. The numerous modifications are described on page 15 of IRS Publication 590 (www.irs.gov/pub/irs-pdf/p590.pdf).

You have until tax day to contribute for the previous year. On April 15, 2007, for example, you and your spouse can each sock away $4,000 for 2006 and $4,000 for 2007. The $16,000 for both of you, compounded at 10 percent a year for 25 years, turns into $173,000. Every little bit helps.

Withdrawals for any reason may be made without tax if the money has been in the Roth IRA for at least 5 years and you've attained 59½.

Withdrawals are also tax free if the money has been in the Roth for at least 5 years and you have not attained 59½, but only if you die, are disabled, or you use the money (up to $10,000) for your first home.

Withdrawals in excess of contributions are subject to income tax with no additional penalty if the money has not been in the Roth for at least 5 years and you have not attained 59½, but only if it's used for medical premiums, certain medical expenses, higher education, or the payments are made in substantially equal amounts for life.

Finally, withdrawals in excess of contributions are subject to income tax plus a 10-percent, non-deductible penalty if the funds have not been in the Roth IRA for 5 years, you have not attained 59½, and you make withdrawals for purposes other than the above.

Next to "tax," the IRS's favorite word is "if."

A Roth IRA is preferable to a traditional IRA. Once you contribute after-tax dollars, the earnings and gains are never taxed again (except for the particulars above), either when the money is in the IRA or when it exits.

If you have a traditional IRA, let it continue compounding without further contributions. Set up a Roth IRA and make future contributions to that.

Assets in a traditional IRA may be transferred a Roth. But the transferred assets are subject to tax in entirety. Should you undertake a transfer? The answer is maybe.

Uncle Sam nixes a rollover altogether if your modified adjusted gross income is $100,000 or more. If it's less, whether you do a rollover depends on where the money to pay the tax comes from. Here are the two alternatives:

• If the tax must be paid from the investments that are being rolled over, estimate whether your tax bracket today (including the taxable rollover) is lower than it will be later on. If so, proceed with the rollover. But if the tax brackets are likely to be the same, leave the traditional IRA alone.

• If the tax is paid from investments not being rolled over and the returns from the outside investments are lower than the ones inside, go ahead with a rollover. For example, say you have a money market fund outside an IRA and stocks within it. Proceed with a rollover and pay the tax from the money market fund.

All IRAs are a pain in the neck. But the best of them is the Roth.