Get Ready for Roth Conversion IRAs

By Johnson, Whitney | ABA Banking Journal, February 1998 | Go to article overview

Get Ready for Roth Conversion IRAs


Johnson, Whitney, ABA Banking Journal


Roth individual retirement accounts, created by last year's tax legislation, offer banks a unique opportunity to capture a share of a potentially enormous market that did not exist last year. Part of the expected explosive growth in Roth IRAs will come from the law's provision allowing individuals to convert their traditional IRA assets into Roth IRAs. Millions of Americans are expected to be in making this shift this year.

Much of the shifting will occur within the same financial institution; however, we are also likely to see a large amount of money shifting between institutions. The latter represents an obvious opportunity to expand your IRA business--and also something of a threat to your existing IRA base.

Early market entry is crucial--no financial institution wants to miss the 1998 conversion market. Additionally, the decisions made about where to make Roth IRA contributions will not just be for 1998, but for many years to come. The market will reward financial institutions that obtain these initial contributions. Offering good investment alternatives is also a factor in gaining market share. Any investment permissible in a traditional IRA is also permissible for a Roth.

Marketing the Roth IRA and then being able to explain it to customers may be the most important factors in obtaining Roth IRA business. Educating people on the Roth IRA will not be an easy task--the rules are complex. Even if an individual is comfortable with how the Roth IRA works, the tax and financial planning issues can be overwhelming. This is especially true for individuals deciding whether or not to convert a traditional IRA to a Roth IRA. In some sense, you must sell the Roth IRA.

That said, Congress created a winner in the Roth IRA, and banks must prepare to take advantage of the new law. This article addresses some of the general issues concerning the new Roth IRA and how to properly convert traditional IRAs to Roth IRAs.

1. What is the Roth IRA?

The Roth IRA (named for Sen. William V. Roth of Delaware) is a new tax-favored savings account passed into law by Congress last summer. The Roth IRA is similar to a traditional IRA in that eligible individuals can contribute up to a maximum of $2,000 and the earnings oh tile account then grow tax-deferred. A key difference between the Roth IRA and the traditional IRA is the tax treatment of the accounts. Unlike traditional IRA contributions, Roth IRA contributions are never tax-deductible. However, qualified distributions from a Roth IRA are tax-free. Distributions from a traditional IRA are generally fully taxable.

2. Why is the Roth IRA important?

It is an entirely new, tax-favored savings product. The tax benefits of the Roth IRA are substantial, and the Roth IRA avoids many of the restrictive burdens found in other tax-favored accounts. Basically, the Roth IRA is a good deal.

3. What makes the Roth IRA such a good deal?

Tax-free gains! The Roth IRA allows for tax-free growth of earnings, a feature few investment products can match. This gift from the federal government comes with some strings attached, however. The good news is that the strings are not too burdensome.

Unlike the traditional IRA or 401(k) plans, the Roth IRA does not tie up an individual's savings until retirement. Individuals will be able to access their principal at any time and for any reason without taxes or penalties. Once someone dips into the earnings in the Roth IRA, then taxes and penalties may apply.

This immediate access to the investment principal is a substantial benefit of the Roth IRA. This feature may prove too good to be true because Congress is currently working to change this aspect of the Roth IRA (but only for assets converted from traditional IRAs). If Congress passes its changes, the principal amounts converted from a traditional IRA may be subject to penalties if not held in the Roth IRA for five years. …

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