The Taxpayers Relief Act of 1997 contains a controversial provision called the Roth IRA. It is controversial because the IRS has not published the regulations for it and because no one has yet figured out what, if any, its advantages are. ORP has been modified so that it can contribute to the controversy although probably not to the resolution.

Very briefly, a Roth IRA is a savings account that is funded with after-tax dollars but returns are accumulate and are withdrawn without paying any Federal Income Tax. There are restrictions:

• Contributions are limited to $2,000 per year for a single person, $4,000 for a married couple. Contributions phase out at $95,000 income for a single person, $150,000 for a married couple.
• Distributions are penalized if taken before age 59 ½.
• Distributions cannot begin until five years after the first contribution..
• An existing IRA can be rolled over into a Roth IRA for wage earners of $100,000 or less.
• There is no minimum withdrawal level that begins at the age of 70 or any other time, as there is with a conventional Tax-deferred Account.

For more information about the Roth IRA see:

• Motley Fool - discusses Roth IRAs.
• Internal Revenue Service - Full explanation of Tax Payers Relief Act changes.
• Dreyfus Family of Mutual Funds - Summary of the Tax Payers Relief Act changes.
• Roth IRA Web Site Home Page - A collection of articles about the Roth IRA.
• T.Rowe Price - Tax Law Changes
• Washington Post - To Roth IRA, Just Say Yes
• Washington Post - Part One: Using the Roth IRA
• Washington Post - Part Two: Using the Roth IRA

The Roth IRA is a different ORP model component than the regular Tax-deferred Account. Additional columns have been added to the current ORP reports to report on the Roth IRA, and an additional Roth IRA account report has been added.

Three new parameters have been added to ORP to include the Roth IRA into the model. They are:

• Planned annual contributions to the Roth IRA before retirement: The contribution restrictions noted above are enforced by ORP except that it is up to user to determine if her Adjusted Gross Income is below the specified limit. Note that these are after-tax dollars so if it is planned to replace 401K contributions with Roth IRA contributions be sure to allow for paying income taxes while figuring the contribution.
• Initial Roth IRA account balance: Since the Roth IRA is brand new, the initial account balance is really a roll over from an existing IRA. Remember to allow for taxes while computing the roll over balance. (Taxes may be paid across four years, which eases the pain a bit.)

Leaving both of the parameters blank in the ORP parameter screen will omit the Roth IRA component from the model.

ORP model runs made to date indicate there is little difference between a regular IRA and a Roth IRA, all other things being equal. This can be seen analytically:

V = (1-t)*b*(1+r**y) is the value of a regular IRA at year y, earning at rate r, starting with before-tax balance b and paying tax rate t at the time of distribution.

R = (1-T)*b*(1+r**y) is the value of a Roth IRA at year y, earning at rate r, starting with before-tax balance b and paying tax rate T at the time of the contribution.

Clearly, if t = T then V = R and whole thing is a wash.

But this is not the whole story. There are several situations where the Roth IRA can profitably be substituted for a regular IRA or used to enhance a regular IRA. No more will be said about this since this in the area of financial advice and the expertise of this site is mathematical programming, not financial planning.

Careful examination of the optimizer’s internal results for several Roth IRA models leads to the observation that the optimizer finds the regular IRA and Roth IRA to be substitutable. The optimizer finds that there are many different forms to the optimal solution; many branches that lead to the same result. This sometime shows up in the ORP model solution where the results will swing back and forth between distributions from the two accounts. What this means is that a particular year’s distribution can be satisfied from either account or from a combination of the two accounts without changing the final result - the amount of money available for spending over the term of retirement.

The three additional parameters described above, when used in conjunction with the other ORP parameters can be used to answer questions about the Roth IRA.

Be sure to include the tax consequences when switching from a regular IRA to a Roth IRA. Taxes must be paid from a rolled over balance before becoming a Roth IRA beginning balance. Taxes must be paid before dropping a regular IRA contribution in favor of a Roth IRA contribution.

Tax considerations can be omitted when supplementing retirement savings with additional contributions to a Roth IRA.

Use the retirement tax rate parameter to account for reduced taxable income during retirement caused by taking money out a Roth IRA instead of a regular IRA.

In 1996, Congress changed the tax law to suspend excess withdrawal penalties on Tax-Deferred Accounts. The reason for this was, as explained at the time, to encourage taxpayers to take large Tax-deferred Account distributions immediately, and pay personal income tax on them. This would increase current government revenues, at the expense of down stream revenues. ORP results indicated that this was not a good idea for most retirees.

Now, in the form of the Roth IRA, Congress is at it again. Rollovers of regular IRAs into Roth IRAs will increase immediate government revenues at the expense of down stream revenues. Several ORP models show that the main difference between rolling over and not rolling over comes is higher taxes paid down stream in the non-rolled over case. Money available for spending remains the same.

Remember that this is all part of the congressional balanced budget package.

Please share your results and observations with us so that we might enhance this section of the web site.