The Taxpayers Relief Act of 1997 creates the Roth IRA retirement savings account. ORP models the Roth IRA in two ways:

1. Before retirement you can specify that contributions can be made to a Roth IRA.
2. After retirement ORP may, under circumstances, indicate that partial rollovers from your IRA to a Roth IRA will be financially benifical.

Very briefly, a Roth IRA is a savings account that is funded with after-tax dollars but returns are accumulate and are withdrawn without paying any Federal Income Tax.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 and are available only to lower income wage earners. The amount of the limitions are in IRS Publication 590
• Distributions are penalized if taken before age 59 ½.
• Distributions cannot begin until five years after the first contribution..

• After 2010 an existing IRA can be rolled over into a Roth IRA without restrictions.
• 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.
• 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.

There are situations when contributing to a Roth IRA is to desirable; other situations when such contributions are sub optimal. 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.

However if t < T which will occur, for example, with a medical student working part time at the fry machine in McDonalds who will have a current marginal income tax rate substantially below her retirment income tax rate. Contributing to a Roth IRA under these circumstances is a great deal.

On the other hand if t > T, i.e. current income is in a higher marginal personal income tax bracket then that anticipated for retirement then a regular IRA is to be preferred.

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.

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