IRA investments miss out on lower gains rate

When stocks are in an IRA and are being
distributed as an IRA distribution, are they taxed as regular income or are they
taxed at capital gain rate? If so, how do you do it? It seems as if they are to
be listed on the tax form in the spot for IRA distributions and taxed at the
regular rate.

R.H., Indianapolis

Unfortunately, your assumption is correct. All amounts withdrawn from your IRA are taxed at regular tax rates. By investing in stocks and mutual funds in your IRA account you deprive yourself of the lower capital gain tax rates. It's too bad this point isn't made clear to IRA account holders when then plan their investments. Because IRA accounts are designed to be tax planning and tax deferment tools, it is imperative that the account owners understand how their holdings are going to be taxed when the amounts are ultimately withdrawn from the account.

I have been told that my share of the cost of my
family's health insurance premium can be paid out of pre-tax dollars if my
employer will allow it. The situation is that my employer pays for my health
insurance costs, but not my family's. I pay that cost by payroll deduction to
the tune of $175 every two weeks. The question is, can the $175 come out before
the tax is calculated? I have looked at the IRS web site but not been able to
find out anything about this.

H.G., Indianapolis

If your employer has a plan in place that allows for you to purchase health insurance with pre-tax dollars, then the IRS will allow it. These plans are very common and many employees take part in them. What will happen is the insurance money will be withheld from your pay. When you get your W-2 form in January of each year you will notice that the total wages on which you will compute your income tax (the amount you put on your tax return as wage income) is lower than the wages used to compute Social Security and Medicare tax. The difference will be the amount of insurance you paid.

Here is an important consideration to keep in mind if you choose to participate in such a plan. Since you are not paying any income tax on the amount of health insurance that is being withheld from your pay, you are not entitled to an itemized deduction for the health insurance cost. Many people don't qualify for the medical expense portion of itemized deductions anyway, but if you have been taking this deduction in the past you should realize that you will no longer be able to take it.

You mention the IRS web site, and this is a good time to
remind readers of this interesting addition to the Internet. You can visit the
IRS on the Internet at http://www.irs.ustreas.gov/prod/cover.html  and view or download copies of all major tax forms and instructions as well as IRS publications, recent rulings, treasury regulations, and tax news. The site is colorful and written with humor (this is the IRS we're talking about?), and an easy place to get around. Keep this Internet address in mind for future reference when you are trying to find last minute forms next April, or if your tax form instructions tell you to "See Publication XXX for additional information."

Do you have to convert all IRAs to Roths in
order to spread conversion income over four years? Plus, if you convert to a
Roth IRA, will you be penalized for not paying estimated taxes during the year?
By this late in the year it would be too late to estimate.

 R.H., Indianapolis

You do not have to convert all of your IRA accounts to Roths in order to take advantage of the four-year tax spread. Any IRA amounts converted to a Roth during 1998 qualify for the special tax treatment of spreading the income over four years.

As with so many aspects of the Roth IRA, the issue of estimated taxes is not specifically addressed in the legislation. However, the rules do state that, "any taxable conversion amount includible in gross income for a year as a result of the conversion is included in income for all purposes." I would interpret "all purposes" to include computation of estimated taxes. It is not to late to make a fourth quarter estimate to cover your 1998 conversion income. Fourth quarter estimated tax payments are due January 15, 1999.

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