Take the Tax Break and Run

Should you trust the Roth IRA?

The first time I was oversold on the benefits of Roth IRAs was when I was interviewing Rep. Mark Neumann (R-Wisconsin), one of many members of Congress who voted to create them. It was late 1997, and I was on Capitol Hill complaining that I was an over-taxed twenty-something.

I asked him why Congress could not use the emerging budget surplus to give us a tax cut to, say, buy a house. Neumann said Congress had just passed legislation creating a new beast called the Roth Individual Retirement Account, or IRA, after the Senator who's name went on the bill that would allow me to save money tax-free for a down payment.

I ask for a tax cut, and you give me an IRA? He looked at me like I should have been grateful.

I wasn't then, and I'm not now. I knew that the Roth held nothing but a far-off promise for me, but for the government it meant money next year.

The Roth IRA is like a traditional IRA (which is basically a tax-free savings account) but with a twist. Unlike traditional IRAs, into which account holders can deposit up to 2,000 tax-deductible dollars a year, Roth IRAs only accept money that's already been taxed. Why should investors give up the $2,000 tax break, which is one of the main selling points of a traditional IRA? Because with a Roth IRA, when you turn 59-and-a-half, the money travels directly to your pocket, without passing the IRS, the state revenue office or Go.

Roths have other nice features: Higher income limits mean more people can use them, investors don't have to cash out at age 70-and-a-half (unlike traditional IRAs) and the money is easier to pass on to heirs. And, after the savings have sat around for five years, a depositor can withdraw the principal and interest to purchase a first house, the benefit that Neumann was originally trying to sell me on.

So why am I ungrateful?

The housing benefit is too clunky to use because it can't be tapped for five years. I'm too young to have any heirs. And I don't trust the government to make good on a tax-free promise that won't come due for 35 years, when I plan to retire.

One can acquire a Roth two ways: Start a new one or convert an existing IRA. The law Neumann and his colleagues passed encouraged individuals to convert their traditional IRAs into Roths by allowing the taxes due on the liquidated IRAs to be paid over four years, through a now-expired grace period. Here's the catch, though: Every dollar converted sends money to Washington that otherwise would have remained safely outside the beltway for years.

Even though the grace period is over, some financial advisors still recommend that individuals convert their old IRAs if they can afford the one-time tax hit. Many claim it's an especially good deal for those of us at the dawn of our careers because we're likely to be in a lower tax bracket today than when we retire and have decades to enjoy tax-free compounding.

"For younger people it tends to make the most sense," says Barry C. Picker, a Brooklyn-based financial planner and author of the self-published book, IRAs at 70 1/2, "because they are the ones who have the longest period of time that the account is going to continue to grow."

I disagree. What Congress creates to raise money, Congress is likely to destroy for the same reason. Picker sees 40 years of compounding. From my perch a block west of the White House and a short cab ride from Capitol Hill, I see 40 years of legislative risk. D.C. pols will figure these nifty accounts cost them money about the time we start to make withdrawals. If we've been successful, we could have hundreds of thousands of dollars, if not more, stashed away. In Washington's eyes, that'll make us "rich," and thus easy targets. (Just ask all the people who got hit with the "success tax," in place from 1986 to 1997, that whacked people with a 90 percent tax rate on retirement savings the government deemed excessive.)

Ric Edelman, financial advisor and author of The Truth About Money, says twenty-somethings who convert their traditional IRAs to Roths are getting cheap tickets to a baseball game that might never be played.

"It's a great deal," says Edelman. "But not if the game is going to get rained out."

Tax breaks should be treated more like a case of beer than red wine; they should be chugged immediately, rather than stored for later consumption. To save for retirement and you should max out your company's 401(k) plan, and only then look to open a Roth. If a 401(k) isn't an option, I say take a traditional IRA over a Roth, unless you trust the government.

I don't. Mark Neumann left Congress in 1998, failing in an attempt to trade up to the Senate. He's no longer around to protect me. And I still don't have a house.