<THE FOOLISH FOUR>

Taxes...
by Ann Coleman
(TMF AnnC)

Reston, VA (September 28, 1998) -- The easiest way to deal with taxes on your retirement investments is to just not pay any.

Before the emails start, let me state firmly that I am quite happy (well, maybe, that's not quite the right word) to pay my taxes, and I have no sympathy for tax evaders or even tax gripers. Hey, as they use to say in the '60s, if you don't like it here, go live in Russia.

But when the government offers us a way to accumulate wealth tax free, I say take it!

That's what the new Roth IRA can do. It's not the answer for everybody, but for those who qualify, the Roth IRA, in conjunction with the Foolish Four, has the potential to create substantial wealth... and let you keep it ALL.

The Roth IRA differs from traditional IRAs in that you can't deduct your annual contributions, a small sacrifice, in my opinion, considering that all of the returns are completely tax free. (Many people find that they can't deduct an IRA contribution anyway if they are covered by an employer's retirement plan and make more than a moderate salary.) With the traditional IRA, you pay taxes at regular income tax rates (not the lower capital gains rates that you might have expected) on all withdrawals. Withdrawals from a Roth are not subject to federal income tax at all.

Who qualifies? Single taxpayers who have adjusted gross incomes (not your salary, but what you actually pay taxes on) of $95,000 or less can contribute the full amount ($2,000) a year. If you make between $95,000 and $110,000 you are in the phase-out range and can still contribute something, but not the full amount. Married tax payers filing jointly have to have an adjusted gross income under $150,000 to contribute the full amount, $4,000 ($2000 each), or be between $150,000 and $160,000 to make a partial contribution.

That's actually a pretty hefty percentage of the population, so let's explore the Roth further. Is there anyone who qualifies that shouldn't take advantage of it?

Well, if you can deduct contributions to regular IRAs (you're are not covered by retirement plan at work or you are covered and have an adjusted gross income of less than $30,000 single or $60,000 married), you will need to consider that you will be giving up you tax deduction. If you need the deduction -- it can be between $300 and $560 for a single person -- and I mean really need it, you might prefer to invest in a traditional IRA. But, even most of those who could deduct the IRA contribution would be better off paying the taxes and putting the money in a Roth IRA instead. Here's why.

First, relax a bit, take a deep breath and put yourself into a long-term frame of mind. Float your consciousness out into the cosmos and contemplate the passage of time. It's twenty-five years into the future. You started your Roth IRA the very day you read this article, followed the Foolish Four faithfully each year and made your contributions on time. You've invested $50,000 of your own cash on which you have paid taxes of $14,000 (at 28%) over the years (or you can look at it as having given up $14,000 in tax refunds). The Foolish Four has continued compounding at approximately the same rate as it has over the previous 25 years (although I've reduced it slightly, to 20% per year, down from 21.86%, just in case) and your account has grown to just over $1,000,000. That's right: One million dollars. And yes, I took out for commissions and even an IRA account fee.

Now, there's a lot of talk these days about how a million dollars isn't what it used to be, but even 25 years from now the TAX-FREE income that such an account can generate should keep you off the streets. (See Friday's column for a more detailed discussion of how that works.) Let's say your need $70,000 to cover your living expenses and that singles' cruise you've been planning. Well, you can take $70,000 out of your Roth, or you can take around $94,000 out of your traditional IRA.

The extra $24,000 is to pay your federal income taxes. You did move to Florida, land of no state income tax, when you retired, didn't you? No? Too bad, you have to take out even more. Either way, that's more taxes in one year than you would have received in tax refunds over the previous 25 years!

Tough choice.

Now, there is the possibility, of course, that you took your tax refund each year and invested it in a taxable account� Yeah, right. Well, some people will and, if they do, they could end up with a regular brokerage account that would make enough money each year to pay the taxes due on their traditional IRA. If you're really, really sure you'll invest it and not spend it, and if you like filling out Schedule D's, by all means, consider that route.

Speaking of a million dollars� If you are married, you can double your contributions and be sitting on a two million dollar pile after 25 years. The more you invest and the longer you let that money just sit tight and work for you, the faster it increases. If you are planning to work for longer than the next 25 years, you might want to consider that while it takes 25 years for your $2000 contributions to turn into the first million, it only takes four more years to get to the second million, and then things get really interesting.

The converse is also true. The money grows relatively slowly at first. In year 15, the account only stands at $166,000 -- SO DON'T JUST SIT THERE -- Start a Roth IRA.

Fool on and prosper!

Current Dow Order | 1998 Dow Returns

What Happened to Robert Sheard?

09/28/98 Close

Stock Change Last -------------------- UK +1 1/8 43.25 IP + 3/4 49.19 MO + 1/8 46.06 EK -1 3/4 79.13

Day Month Year FOOL-4 +0.39% 11.68% 13.14% DJIA +1.00% 7.56% 2.54% S&P 500 +0.38% 9.52% 8.06% NASDAQ -0.25% 16.01% 10.75% Rec'd # Security In At Now Change 12/31/97 206 Eastman Ko 60.56 79.13 30.65% 12/31/97 289 Int'l Pape 43.13 49.19 14.06% 12/31/97 276 Philip Mor 45.25 46.06 1.80% 12/31/97 291 Union Carb 42.94 43.25 0.73% Rec'd # Security In At Value Change 12/31/97 206 Eastman Ko 12475.88 16299.75 $3823.88 12/31/97 289 Int'l Pape 12463.13 14215.19 $1752.06 12/31/97 276 Philip Mor 12489.00 12713.25 $224.25 12/31/97 291 Union Carb 12494.81 12585.75 $90.94 CASH $754.73 TOTAL $56568.67