Individual Retirement Accounts (IRAs)

Recent changes in the Nation's tax laws have made Individual Retirement Accounts available to many people previously excluded. This report provides general information on IRAs including material explaining these recent changes and their consequences.

c7 Congressional Research Service The Library of Congress -m 4 r) ** INDIVIDUAL RETIREMENT ACCOUNTS (IRAS) IP0177I Recent changes in the Nation's tax laws have made Individual Retirement Accounts available to many people previously excluded. Enclosed is general information on IRAs including material explaining these recent changes and their consequences. Additional information on this subject, primarily in periodicals and newsDaDers., mav be found in a local library through the use of indexes such as the Readers' Guide to periodical Literature, Public Affairs Information Service Bulletin (PAIS), and the New York Times Index. L A < We hope this information will be helpful. Congressional Reference Division COMPLIMENTS O F Gene Snyder } COMMITTEE PRINT Xi Wi 0 11 S WASIIINQTON 1991 GOVICRNMENT P R I N T I N G OBFICI<: This document has been printed for information purposes. It does not offer flndings or recommendations by this committee DECEMBER 1981 SPECIAL COMMITTEE ON AGING. UNITED STATES SENATE PREPARED BY T H E S T A F F O F T H E AN INFORMATION P A P E R ACCOUNTS (IRA'S) A. GUIDE TO INDIVIDUAL RETIR,EMENT 97th Congress 1st session Question. Do I have to put $2,000 in my IRA every year to keep it alive? Answer. No. There is no minimum contribution requirement. ()uestion. Mtiy I stagger my investment over the yenr? Answer. Yes. Or the entire amount may be invested nt one time. Contributions 13 nn IR.1 must be in the form of cash, check, or money order. Ouestion. What is the cutoff date for contributions to the IRA each year? Answer. Contributions may be mpde through the due date for your income tax ~ e t u r ninclutling , extensions. For most people that date is .Ipril 15 of the yew following the yeru when the income was earned. (juestion. T h e n is the last date each yenr when I may set up an IRA? Alnh\ver.The due date for filing your tax return, with extensions. (Juestion.Where mny IRA money be invested? Answer. IRA money mtty be investecl in such things as passbook savings nccounts, certificates of da oslt, annuities, mutual funds (including money market funds), i;PriYidurl stocks and bonds, find certain kinds of red est'ate, such as lmtnitetl real estate investment. partnerships. Question. Are any investments forbidden? Answer. Yes. Assets used to acquire a collectible are treated as immediate distributions from the account and are taxed accordingly. They may also be subject to penalties for premature distribution. Collectibles include works of art, nntiques, metals, stamps, coins, and alcoholic beverages. Money invested in life insurance contracts generally docs not qualify for an IKA contribution. (Annuities do qualify.) Question. Is there any limit on the number of IRA'S aperson may have? Answer. No. But only a combined total of no more than 100 percent of compensation or $2,000, whichever is less, may be invested each year, no matter how many IRA'S are set up. Question. Is there a penalty for putting more than the deductible limit into an IRA in any one year? Answer. Yes. An excise tax of 6 percent is levied on any amount contributed beyond the deductible amount-unless the excess and any earnings on the excess are taken out before the due date for filing an income tax return for the year. Qursiic,:i. 15 thcrc: loii.er or upper income limit for IRAZeligibility? i1ns\vw. S o . ( j u ~ s t l o n Is . there 11 lirn~ton the tmount of time 11 perzon must work each yew to qrlulify for tin IJLI? Answer. No. Question. Are part-time workers eligible? Answer. Yes. MAKING A N IRA IXVESTMENT Question. Do I pay any taxes on the money I put into an IRA each year? Answer. No. That amount-the lesser of $2,000 or 100 percent of taxable compensation for the year-is taken off the top of your income and is not taxed until i t is distributed to you. Y (juestion. At whut age may I open nn IRA? Answer. There is no minimuni tge. You may not, however, deduct payments you make to an IRA if you will be 70): before the end of the year. (Suestion. When may I withdraw money from my IRA? Answe~.Normally, you mny start to withdraw your money a t age 59%. (Early wikhdmwals are permitted upon disability or death.) (Suestion. Must my money be withd~awnby a certain age? Answer. You must begin to receive payments from your account before the end of the yenr in which you become 70)& whether you are retired or not. You may not invest any money after you reach 70);. There is a heavy enalty for failing to make proper distribution of the money. Work c osely on this with the institution where your IRA is set up. Question. How is the money in my IRA paid out to me? Answer. The money can be paid out in various ways. You may take the entire amount in a single payment between 59;h and the end of the year during which you reach 705. Or you may elect to receive the money in regular payments over a fixed period of time that is not greater than the life expectancy or the combined life expectancy of you and your spouse. Or you may choose an annuity that would make regular payments for life or the combined lives of you and your spouse. Payments must begin by the end of the tax year during which you become 70:i. IJuestion. iM:ly I move my I R A wcouut! Answer. Yes, you may withtlr~twpart or d l of the assets from one IR.2 and invest them in another IR*i, tax free. Thls is known as rt "rollover." Question. When must this investment be made? Answer. Ry the 60th day after the day you receive the money from your IRA. Question. How often may I do this? Answer. You must wait a t lenst 12 months between rollovers. Question. Is there any way I may move my IRA from one institution to another more than once a year? Answer. Yes. If the money does not pass through your hands but is handled exclusively by the institutions involved, the transaction is not considered u "rollover" and the 1-year waitling period does not apply. AGE ~ M I T AS N D WITHDRAWALS b The simplest way to invest your I R A dollars is in a passbook savings account. But, financial institutions are also offering other IRA investments with higher returns th&nthe passbook yavings rate. P What can an IRA do for you? Take this example, developed by a financial organization: You are ~ermitteda maximum investment of $2,000 a year in an IRA. After 20 years, you would have $161,397 if you invested all $2,000 on January 1 every year at 12 percent simple interest, compounded over 20 years. After 40 years, the same investment would produce $1,718,285 and would make you'a millionaire. But let's kee things in perspective. You would still have a real nest egg. But al owing, say, for inflation of 5 percent a year, 40 years from now $1,718,285 would buy goods worth approximately $244,110 in 1981 dollars. IRA OPTIONS Question. Is interest or other money earned by my IRA taxed each year? Answer. Money is not taxed as it accumulates in lour account. There may be a few special exceptions to this. Question. When is my IRA taxed? Answer. When you withdraw money from your IRA, it is taxed as ordinary income, unless you "roll it over," tax free, as described above. There is a tax penalty if you withdraw money before you are age 59':. A penalty-free withdrawal can be made upon disability or death. Question. What is the penalty for withdrawing my money early? Answer. The amount withdrawn will be taxed as ordinary income and a 10 ercent adtlitionel tax will be charged on the amount withdrawn. TFle additional tax is nondeductible. This penalty does not apply to an early withdrawd that is 'Lrolletlover," tax-free. Question. Does my IRA become part of my estate after I die? Answer. The remaining amount in yollr IRA is not subject to Federal estate taxes if it is paid to your beneficiary during his or her lifetime or during a period of at least 36 months. ITowever, a lump-sum ayment to your beneficiary is included as part of your estate for gederal tax purposes. Question. How about gift taxes? Answer. A distribution payable to a beneficiary will not be subject to Federal gift taxes. Question. Where can I get more information on IRA'S? Answer. No matter where you live there will be a tax information number in our telephone book. Look for it under United States Government, Tnternal Revenue Service. Call that number and ask for Publication 590, Tax Information on Individual Retirement Arrangements. Y, e : Almost all credit unions will be offering IRA'S. They expect to pay interest that is competitive with other financial institutions. Credit unions are chartered by the Federal Goveinment or by the States. Every Federal credit union is free to decide what kind of IRA it will have, inclutlin the interest it will pa . State-chartered credit unions also will tleve op their own plans, alt ough some States have interest ceilings. Credit unions will design IRA'S keyed to their size an(! ntltr~re. Interest will be set by the board of directors of t,he credlt union. Some IRA'S will have no time limit. Others mtiy offer s~~vings certificates with a time limit tint1 would chnrge t i pennlty for pretnt~tr~re withdrawal. k I Banks are offering a variety of options on IRA'S that are patterned after conventional certificates of deposlt but are far more flexible. Even within the same bank more than one option may be available. Conventional certificates of deposit require sizable initial payments. But an IRA account can be opened with a modest amount, perhaps $100. After that you can de osit as much as you like, whenever you like, depenchng on the legal emit per year. You can even stop paying and your account wlll remain active. Generally speaking, banks won't charge maintenance costs. The different options in IRA'S will revolve around the kind of interest being offered, the amount of interest, and the length of time of the certifichte. Some IRA'S will have variable, or floating, - interest rates. Others will have fixed interest rntes. Both rates generally will t,ake as their guide the rates of U S . Government securities and other investments. This does not mean the IRA necessarily will be aying the same amount as the securities. I t could be paying more. &it the variable, or floating, mte, on the IRA woultl fluctuate along with the security's fluctuations. Interest on our account would be ad'ustetl regularly. +he fixed rate rill stay t e same throughout the timespan of the certificate, when new terms would be set. Alt,hou h IRA certificates will have time limits of at least 18 months, some ban s will renew IRA1swith variable interest rates automatically if the customer wishes. Your IRA robably won't have the same interest rate throughout its lifetime. W en your certificate matures you can move your account elsewhere if you are dissatisfied with the new terms proposed. But the bank may charge a penalty if you move the money before the certificate's maturity. A'ccounts in the vast majority of commercial and mutual savings banks are federally insured up to $100,000. Others are not, but they may be insured under your home State. BANKS Banks, credit unions, savings and loan associations, insurance companies, mutual funds, and Investment brokers all are courting the IRA customer. Here is a rundown on options private financial institutions are making available. * An IRA set up with an insurance company is an annuity. An annuity uarantees you an income as long as you live. It is the o d y IRA t%at can provide this guarantee. t' Savings and loan associations will be offering a range of options which are variations of conventional savings certificates that are tailored especially for IRA's. Some savings and loans will offer more than one option. IRA's a t savings and loans will differ in the kind of interest offered, in the rate of interest, anti in the length of time the savings certificate runs. Interest rates generally will be pegged to the rates of U.S. Government securities or other investments. Most savings and loan associations will choose an interest rate that the customer can understand easily, such as the rates on Government securities that are published regularly in newspapers. This does not mean the interest rate must be the same as the rate on the Government security. The savings and loan could be offering higher or lower interest. Some IRA'S will have a variable, or floating, interest rate that will rise or fall when the rate changes on the security to which it is pegged. Adjustments in the inkerest rate would be made regularly. Other IRA'S will have fixed interest rates that will remain the same during the time period of thc savings certificate, which could be for 18 months or could run for several years. Your IRA plan robably won't have the same interest rate throughout its lifetime. $hen your savings certificate matures you are free to move your IRA elsewhere if you are not satisfied with the new terms proposed. However, if you take your money out before the certificate's maturity, the savings and loan association may charge a penalty. Savings and loans generally require a modest deposit-for example, as low as $10-when you open your account. After that you may deposit what you like, when you like, as long as you don't exceed the legal limit each year. You can even sto paying and your account will remain active. Maintenance genera ly will be free. Accounts in the vast majority of savin s and loans are federally insured up tu $100,000. Others are not, fk~tthey may be insured under your home State. SAVINGS A N D LOANASSOCIATIONS Convenience is one of the t~ssetsof 11 credit union, nntl man unions s i l l mt~xirniae convenience by offering ptlyrol~ (letL,"f% fol their IRA's. The initial tleposit requiretl qeneially n-odd be very Ion-, s ~ c h11% $25 or Iehs. For those not trtklng titlvclntnge of ptiyroll tled\~ction, ndtlitiont~ldeposits generally coultl be mcitle at m y ,time m t l in any amount, ns long cis they don't exceed the legal limit each year. For the most pnrt, no mthtennnce fees will be chnrgerl. Accounts in Federal credit unions are federally insured up to $100,000. Some State-chartered institutions also are federally insured. Others may be insured by the State for a comparable amount. !I 1 t: f "h When you put your money in a mutual funtl you are buying shares in a pool of money that is invested in securities chosen by professional money mana ers. The most amous type of mutual fund is the money market fund, where money is invested in short-term securities and your rate of return varies daily. Other mutual funds invest in stocks and bonds. Every mutual funtl is made up of a group of securities. There are hundreds of mutual funds, designed to meet different objectives oE nvestors. Mntual funds do not uarantee a specific rate of return on your investment. Some funds ave far outstripped increases in the Consumer Price Index. But it also is possible to lose money in a mutual fund investment. Mutual funds are known as load and no-load funds. The "load," or charge, is a sales commission paid to a broker or sales agent for advice and services. The sales charge usually is around 8.5 percent of the cost of every purchase of shares in the fund. 4 h Insu~.ancecomp?nies will tell you in the beginning what the fixed minimum rate of interest will be on your money through the years. The atlvantage i s . t h t ~ gunrant'eetl t interest is not subject to mnrket fluctuations. This interest rate coultl be spelletl out in stages in your policy. For example, the guaranteed rate could be relatively high in the first or early years, and then lower for succeeding years. On paper, the guaranteed rate of insurance companies has been considerably lower in recent years than rates offered by other financial institutions. In realit ,, insurance companies have been paying interest !vhich is more than t e guaranteed rate ant1 is competitive m t h other institutions. The only guaranteed rate, however, is the one spelled out in the policy. IRA's have flexible remiums. This means you can put as much as you like in your I R a t any time, as long as you don't exceed t'he maximum set b law each year. You can even stop paying and your policy still \ d 1 e m force. Some companies will accept $50 or less as an opening amount,. Some companies are tailoring policies especially for IRA'S b offering fixed interest annuities that have no '.front loads," whic are sales cost's. Your entire invedment will be earning money for you. But you can expect to pay sizable enalties if you withdraw your money rematurel , particularly in t e early years of the policy. This is ca11erP'~backloaB~ Maint.enance fees for IRA's will run around $20 or $25 a year. Your fixed annuity also guarantees a rate upon which payments t,o you mill be based. You can never get less, but you coultl get more. Some insurance com anies will also on'er IRA'S t'hat do not have guaranteed interest. T ey are called variable annuities. The value of the annuity fluctuates, tlepentling on market condit:ons. They generally will have sales costs. Money in your annuity will not be federally insured, but State agencies that regulate insurance companies emphasize safety and diversit,y in investments. POINTS TO CHECK When it comes time to shop for your IRA, remember thb: It's a buyer's market. Financial institutions are competing aggressively for your money. First of all, find out if your employer is accepting deductible, voluntary IRA-type contributions to a pension plan. ‘f Brokers offer the widest range of IRA choices. For example, brokers at investment firms can set up IRA'S in mutual funds. The can arrange to put your I R A in a limited partnership built aroun income-producing real estate. They can help you select an annuity. If you want to manage your own invesiments, they can help you arrange for a self-directed individual ret~rementtrust that will qualify as an IRA. Investing in securities, however, carries the risk of loss as well as gain. You may find that some IRA investments made through a broker will have higher costs associated with them than other IRA'S have. A broker will charge about 8.5 percent of the cost of every purchase of shares in a mutual fund. Even in a self-directed IRA, you will pay a broker's commission,when you buy or sell stock. Thefe also will be some costs for establishing the plan and administering it. In some cases, the kind of investment you select will require commitment to a specific investment, up to the limit of. the IRA. For example, you could be required to invest $2,000 at one tune in a limited real estate partnership. Investments made through a brokerage firm are not insured against loss due to normal market action. However, client accounts are insured up to $500,000 against loss due to failure of the firm. x Generally speaking, shares in no-load funds are not purchased from a broker. Money market funds, which are no-load funds, are an exception to this. There is virtually no difference in the investments of no-load and load funds. You must be given a prospectus spelling out the objectives and terms of each fund. You can move your IRA from one mutual fund to another as your own investment objectives change. Generally, there are no charge when you sell fund shares. Some funds may require that you invest at least a minimum amount-perhaps $100-every time you buy shares. Others require no minimum. Each year, there will be a management fee that is usually around 1 percent of the value of your shares. Money market funds generally charge half this amount. Many funds also charge a maintenance fee for your IRA of about $10 a ear. Mutual funds seek to ac ieve investment growth, safety, and stability through diversified investment, but you should carefully check the sales prospectus to evaluate how m~!ch risk is involved. In a mutual fund, your money 1s not insured aga~nstloss due to normal market action. INVE~TMENT BROKERS 0 'i 7 IHA Also, find out if your em loyer has agreed to a ayroll deduction an for IRA'S that is not rJatted to a pension plan. !'he mone would you invested by a financial institution and you could select the want. The range and nature of investment options might be greater than if you went to the financial institution as an individual. Still, you may prefer to locate an IRA on your own. Be sure to shop around. Ask to talk to the IRA specialist at various financial institutions. They all have one. Make sure the institution has been ap roved for IRA'S. Banks, savings and loan associations, and federa ly insured credit unions are eligible to act as trustees automatically. Other institutions must be certified by the Internal Revenue Service. Ask the institution for written proof of certification. Consider what you want an IRA to do for you and ex.plore in those terms. Assess your temperament, age, and retirement income needs. Weigh the relative safety of your investment options. Generally speaking, the closer you are to retirement, the more conservative your investment choice may be? particularly if you will be de ending heav1 different ~ ily on IRA dollars. You might also consider opening 1 ~ 1 in financial institutions to diversify your retirement investments. Make certain to get the disclosure statement required by law. The trustee must give you an explanation of all the income tax consequences of opening and maintaining an IRA account. If the rate of return on the IRA is guaranteed or can be reasonably projected, this disclosure statement must ive you a projection of the growth of the program a t the end of eat[ of the first 5 years of the contract and at age 60,65, and 70. Among other things, the statement also must give startup and administrative costs. If the investments are made in mutual funds or on the open market, you must insteed be informed of what sales and administrative charges will be made against your contrib~~tions and how annual earnings are fi ured. Ask about &e minimum amount required by an institution to open an IRA. Make a point of understanding the kind of interest, or other ret,urn, that is being offered. Ask how interest will be calculated, too. I t makes a difference in the dollars coming to you. Interest rates and fees will vary from institution to institution and from locality to locality. Understand, also, that in man cases, interest rates will not remain the same during the life of your I&A. Keep in mind that you can move your IRA without in( urrin a tax penalty, but the institution you are leaving may charge tl pena ty for early withdrawal. Finance New savings plans can help you prepare for retirement. But there are rules to follow and choices to make. Here's what you need to know. $2,000.If you run a business, it may pay to hire your spouse part time to d o w both of you to have IRA's. The main limit on IRA contributions is that you can't contribute more than what you receive in on-the-job compensation. That's of special interest to part-time workers. Nor can you make only have $26,000 after contributing contributions if your only income is $2,000to an IRA. For a married couple from interest, dividends or other nonfiling a joint return, that reduction employment sources. means a 1982 tax saving of $580. In As long as you don't exceed the yeareffect, it costs this couple only $1,420 ly ceiling on contributions, there is no to make a $2,000investment. The sav- limit to the number of individual IRA'S ings are bigger for people in higher tax you can have. Moreover, you are not brackets, smaller for people in lower locked into an IRA. Within limits, you tax brackets. can close old IRA'S and open new ones, m Interest and other earnings on the or sometimes switch the type of investIRAinvestment, including capital gains, ment within an IRA. The tax .rules accumulate without being immediately don't require you to put money in evtaxed.That lets the value of your IRA ery year, and the payments you make snowball since the balance upon which don't have to be in a lump sum. Some you can earn investment income isn't sellers of IRA investments, however, reduced by a tax bite. may require a minimum deposit. Self-employed persons can set up Who's Ellgible IRA's, too, even if they also have IRAUntil this year,IRA's had been limited like Keogh retirement plans. to people who weren't covered by an employer-sponsored retirement plan. Returns You Can Get Last year's big tax-reduction bill The key to benefiting from an IRA is changed that. Starting in 1982,anyone to "start early and contribute consiswho gets compensation from employ- tently," says Gary Strum, a vice presiment, including fees for professional dent at E. F. Hutton & Company, the servicesor income from part-time work, investment firm. can set up an IRA, even if also covered For example, a person who is now 40 by an employer's retirement plan. years old and pays in $2,000 a year to An individual holding a job can put an IRA that earns 8 percent a year up to $2,000a year into an IRA.Open compounded quarterly would accumua separate account for a nonworking spouse who doesn't receive apy pay during the year, and you can put away a combined total of $235O-split in any ratio, but no more than $2,000to either account. If you and your spouse both work, you can each invest up to Working hmericans who are willing to start socking away cash for retirement are now getting a big new h e l p ing hand from Uncle Sam. Effective January 1, tax breaks reward individuals who put up to $2,000 a year into a special savings planknown as an individual retirement account-to build a nest egg for the future. Money put into an IRA can be invested in any number of ways-from simply opening a savings account at a bank to trading in stocks and other securities. You can have a professional manage the money in your account or you can do it yoursel€. As a result, a whirlwind of bidding is under way by firms seeking to handle the flood of investment money. Banks, savings m d loan BSSOCiations, mutual funds, credit unions, insurance companies and stockbrokers are all offering IRA investment plans. Some companies are setting up payrolldeduction plans for IRA contributions. Financial institutions are "fighting tooth and nail" for this money, says William Donoghue, publisher of a newsletter on moneymarket mutual funds. The American Bankers Association says more than 50 billion d o k s a year could flow into IRA programs, although much of this money will come from cash Here's what could happen to an individual earmarked anyway for inretirement account in which $2,000was it?vestments and savings. vested each year- Tax Bendits What makes IRA'S attractive are two big tax benefitsThe money that you contribute to an IRA is deductible from your income before calculating how much federal income tax you owe, even if you don't itemize any other deductions. For example, a person who would otherwise have annual taxable income of $28,000 would Am Total *t;dn ~ e p o dby t Dollas Accumulated at mrted Age 65 8% Interest 12% Interest 30 35 40 45 50 55 60 $70,000 $60,000 $50,000 $40,000 $30,000 $20,000 $10,000 $393',853 $256,456 $163,999 $101,778 $ 59.905 $ 31,726 $ 12,762 $1.lO6,452 604,611 326,754 172,911 87,732 40,570 14,458 $ $ $ $ $ $ Double the amounts for a working couple who contribute $4,000a year. Note: Figures assume deposits made at start of p d , with interest compounded quarterly. Vs. Inflation's Erosion Annual Rate of infhtion 6% 8% 1O0b 12% 14% V.lw of Today's SlO0,OM) In 5 15 25 Y e a Years Years $74,726 $68,058 $62,092 $56,743 $51,937 $41,727 $31,524 $23,939 $18,270 $14,010 $23,300 $14,602 $ 9.230 $ 5.882 $ 3,779 curities, mutual funds, options and realestate partnerships. Note: Deposits to an IRA must be in cash. You can't contribute assets, such as stocks, you already own. Also available for investment are special U.S. individual retirement bonds, available from Federal Reserve banks and the Treasury. They yield a relatively modest 9 percent a year. Specifically prohibited for new IRA investments are gold, art, antiques, diamonds, coins and other so-called collectibles. An alternative is to invest indirectly in such assets-shares in a gold-mining firm, for example. Experts suggest you stay away from tax-exempt securities, such as municipal bonds. The reason: The interest on such securities are less than on other investments and yet don't escape tax in an IRA-they are taxed when withdrawn. More controversial is the question of investing in stocks. Some analysts look late $164,000 by the time he or she Many people are likely to open ac- eskance at buying securities for longreaches 65. If the IRA earns 12 percent a year, the balance will reach almost counts at banks or savings and loans, term price appreciation because shares $327,000;start at age 30, and by age 65 which have garnered the bulk of IRA'S held in an IRA don't get favorable you can have more than 1 million dol- in the past. One big drawing card: Fed- long-term capitai-gains treatment. Inlars stockpiled, even though your con- eral insurance for up to $100,000. After stead, these analysts suggest buying tributions totaled only $70,@. One your IRA tops that amount, you can stocks that pay big dividends, or highNew York S&L advertises: "Retire a open more at other banks and SgcL's to yielding debt issues such as bonds and government securities, to benefit from millionaire for just $166.66 a month." stay fully insured. IRA funds can be put into any bank the tax deferral in an IRA. Others, But don't let the gargantuan figures blind you. Behind the assumption that or S&L account, but most heavily pro- however, say that even though you you can earn 12 percent a year, for moted are certificates of deposit specif- give up capital-gains benefits, stocks instance, is an assumption that high in- ically aimed at IRA funds. They have a may still be the best bet for long-term flation will continue. If that is so, by the maturity of 18 months or more and can growth to outpace inflation. Many employers are allcwing payroll time you retire, 1million dollars wori't pay any rate of interest an institution be worth nearly as much as it is today. wants, though the rate is generally deductions to IRA'S; this offers conveIn addition, an IRA only defers tax; it linkea to that paid on government and nience and often lower costs. NCR doesn't exempt you from it. When you other money-market securities. Some Corporation in Dayton, Ohio, for one, start withdrawing funds, you will be banks in December were offering up gives employes a choice. They can funtaxed on all you take out--at regular to about 14 percent a year on such nel their money to NCR's credit union, income-tax rates. Moreover, no special CD's. Many institutions offer a choice: a mutual fund that is managed by T. favor will be given to IRA earnings A certificate with a fixed rate or one Rowe Price Associates, or a program from long-term capital W c h as with a rate that varies with money- run by Connecticut General Life Insurthe sale of stock held longer than a market yields. Credit unions also may ance Company for investing in longterm securities. year. Capital gains will be taxed the offer special IRA savings certificates. The new law also allows employers same as other income, rather than at Mutual funds hope to pull in a large the lower rate that normally applies. share of IRA accounts because of the to accept IRA-style deposits to a firm's hievertheless, financial advisers say flexibility and variety of investment own pension plan, although that apU ' s still shape up as a good buy. They that funds allow. Some investors are proach appears to be less popular. also note that the tax bite may be eased expected to start off with money-marat retirement when you presumably ket funds, possibly switching later to Wittrdrawals will be in a relatively low tax bracket funds investing in common stocks. Though IRA'S are billed as a way to because you won't be working. Dreyfus Service Corporation, as one save for retirement, your age rather In addition, advisers say that people example, allows its IRA clients to than job status determines when you should start IRA'S because Social Secu- switch without charge between six mu- can withdraw money. You can take rity and private pensions cannot be tual funds it manages. Included are cash out without penalty, gradually or counted bn to provide all the cash bond, stock and money-market funds. all at once, as early as age 59M, and the needed for retirement. Insurance firms offer several plansbalance still accumulates tax deferred. Despite the hoopla, there's no need including annuities that guarantee a Unless you become disabled, withto fmh into an IRA. Though opening minimum income level for life after drawals before 59% are subject to a tax an IRA early this year will get you a you retire. penalty of 10 percent of the amount The greatest flexibility is offered by withdrawn, in addition to your being fast start on earning tax-deferred income, you can wait until you He your accounts you can manage yourself hit by income tax. The same age limits 1982 tax return in 1983 to open an IRA through a stockbroker. Merrill Lynch on withdrawals apply to a spouse for or make a contribution to one, and still lists 19 investments open to its IRA whom you've opened an IRA. There's clients, including stocks, bonds, U.S.se- no early withdrawal penalty if you die, get a 1982 tax deduction. U.S.NEWS & WORLD REPORT. Jan. 1 1, 1982 in which case your IRA arisets can be passed on to heirs. Note: You can't get around the earlywithdrawal penalty by borrowing from an IRA or using its assets as collateral for a loan. Do that and you are subject to penalty and tax as if the amount were an early withdrawal. Nevertheless, advisers say that people shouldn't let the withdrawal penalty scare them. That's because the tax breaks are so large that in some cases in future years you may come out ahead even if you must incur the penalty. You must start withdrawing from an IRA after you reach 70%.At that point, the withdrawals must be at a rate fast enough to deplete the IRA over either your life expectancy or the joint expec tancy of you and your spouse. You can make contributions to an IRA up to the year in which you reach 70%. But even people under 59% can take out IRA funds temporarily without incurring a penalty or tax. Once a year you can close an IRA and hold the funds for up to 60 days before rolling them over into a new account to avoid tax or the 10 percent penalty. You can use the funds as a short-term loan or invest them to get current income. If you want to switch an IRA more than once a year, the institution holding your account must transfer it to the hew institution, thus keeping the funds out of your hands and preventing you from bemg hit with tax or pedty. Note: ~ h o u g hyou avoid tax penalties in such a transfer, you may run into extra charges levied by the institution in which you have your IRA-an earlywithdrawal penalty on a savings certificate or a redemption fee on a n insurance annuity,for example. The Cost When opening an IRA, there are often initial charges to pay, as well as nn annual fee, sometimes based on the value of the account. But the levies are generally snall. Banks and SBeL's usually charge nothing to open an IRA and $10 or less a year to maintain it. Many mutual funds charge $5 to $10 to open an IRA and less than $10 a year to keep it up. Self-directed accounts at stockbrokers may cost up to about $30 to open, with a maintenance fee of about $25 or higher depending on the account's size and ty+. You also @y commissims on the purchase of stocks and some mutual-fund shares and insurance annuities. The best advice: Shop around, don't be misled by fancy sales pitches and be wary of promises of high future yields that may not be met. C By LEONARD WLENE?i U S N E W S & WORLD REPORT, Jan 11. 1982 52 THE WALL STREET JOURNAL, Monday, December 14, 1981 Your MQney Matters Ir to put your e u r IRA 1Lmk at Risks, Management and All the Fees I By JILL B m m Bylf Rcponer uf I h u Was. SR~PCT JWWL For mlltions of people, the question isn't whether to open an individual retirement account (IRA) after Jan. 1, but where. Financial institutions. brokerage .firms. credit unions. insurance companies and mutual fu$s are all competing for your busipess, as you have undoubtedly noticed from the barrage of advertising in recent weeks. Whatever investment you choose, any amount that you contribute to your IRA will be tax-deductible, up to $2.000 a year, or a total of $2350 for yourself and a nonworking spouse. The earning can be left to accumulate -free until you reach at least age ~ n fees y for setting up or maintaining an Brokerage FLrms. The big brokerage houses offer the most variety of investments, although you will pay more in fees for your IRA than you will at financial institutions. And brokerage retirement accounts from various institutions: aren't covered by federa! deposit Wrance. Banks. Thrift ~ t i o n sand Credlt Basically, there are two ways to @.'A Unions. The options include certificates of self-directed IRA lets you buy and sell deposit with a choice of maturities, as well stocks and bonds as you like, or control inas regular passbook savings accounts. Their vestments in such things as real estate, oil fees are the lowest,'and IRAs are federally and gas or equipment leasing. At Paine insured, up to $100,000. Webber Jackson & Curtis Inc., investors can New are 18-month certificates, permitted buy mortgage securities insured by the Govonly for IRA5 and Keoghs, which are retireernment National Mortgage Association 58%. ment plans for the self-employed. These (Ginnie Mae). The fees, which are typical of Deciding h' to lnwst depends on the "wild-card CDs can carry any interest rate those the firm charges for all of its self-dirisk you will accept in return for a possibly that a financial institution chooses to pay. rected accounts. are 525 to open an IRA. higher tax-free yield, whether you want to Most banks and savings and loans are curbrokerage commissions of $30 per $1.000 incontrol your IRA yourself or have it profes- rently advertising rates of between 14% and vested, plus a S25 annual maintenance, or sionally managed. and how much you want 15% on either fixed- or variablerate 18- custodial, fee. to pay in assorted fees (see accompanying month certificates. Minimum deposits can Memll Lynch will charge $30 to open any be as low as $1. Credit unions can vary the tabk). kind of self-directed IRA, plus brokerage No matter where you put your IRA dol: terin. as well as the rate, on any certificate commissions. The annual mamtenance fee tars. if you dip into the account before age they decide to offer. wll be the greater of $50, or two-tenths of 58%. yon will pay a penalty tax of lo?" on .If you have an existing IRA or'~eogh, 1% of the assets in the account as of Dec. 31 the amount withdrawn. And. the money you and you are stuck with an old, low-interest each year. Bache Halsey Stuart Shields Inc. take out will be taxed as ordinary income. savings certificate that hasn't matured, you will have fees of $25 and a minimum annual For instance, if you accumulate $10.000 in can avoid an early-withdrawal penalty and fee of $35. an IRA and decide to take out $2,000 before still start earning more on contributions tw The lower-cat route at a brokerage firm you reach the magic age, you will pay a ward your rehrement savings from now on. is to invest in any of the professionally manpenalty tax of t200. The other 58,000 will reA financial institution can assess an earaged mutual-fund packages the firm sells. main sheltered. If, however, the $10,000 w s ly-withdrawal penalty, which requires you to ?Lplcally, the packages include a moneyinvested In a bank certificate of deposit or forfeit at least the last six months' intergt. market fund and several types of stock an insurance annuity, you. could also pay only Lf you invade the certificate's principal. funds and bond funds. Also available are other penalties for getting at the money But you can withdraw the accumulated infunds that combine stocks and options. terest without penalty any time. (The same There is usually a fee of about 8 to switch early. out of one fund and into another. Still, the tax penalties for early with- $ true of any kind of savings certificate.) Use the interest you have piled up to drawals from an IRA aren't prohibitive. AfMerrili Lynch will charge $15 set up a open a higher-paw I R A or Keogh, and diter a few years, they can effectively be paid mutual-fund account, plus an annual c u t e rect that the future Interest on your old c e r out of tax-free interest. dial fee of $20. Dean Witter Reynolds Inc. also be paid to the new plan. It is (Note: While annual contributions to the tificate will charge $20 and 520. respectively. called "bleeding" an account, and although new universal IRA are a write-off on your banks hate people who do it, few of them "No-bad" blutnal Fund federal tax return starting in 1982, many Firms like the Fidelity Group. the DreyruS charge any fee for such automatic Interest states, including New Jersey and California. transfers. Service Corporation. T. Rowe Price and the haven't amended their laws to make the Vanguard Group offer IRA investors several contributions deductible from state income professionally managed funds without sales taxes. Most state legislatures, however, are charges. expected to act in time for claiming the full deductions for 1982.)' IRA are m deductible fmm federal taxes. whether you choose to pay them out of Your annual contributions or separately. Here is a sample of the types of investments available - -a-" At most companies there won't be a charge for setting up the account or for switching between funds. Annual manage ment fees typically will run $10 or less. All of the big companies are also aggressively marketing theirfunds for payroll-deduction mks. If your employer offers such a plan, participating in it could c a t you less than buying the funds direbuy. Insurance Companies. The products are called Individual Retirement Annuities. Their biggest selling point is that they are guaranteed to provide a certain amount of income each year after yw retire. The payout, per $1.000 you invest, is based on average life expectancies. as well as the value of the investments purchased with premiums. There are two main types of i'nsurance IRAs. Prudential, for instance, will offer a "front-loaded" annuity that will carry a sales charge of 8.75% whch comes off the top of each 51.000 you put in over the years. Tie initial interest rate. which will be ad-. justed hnnually. will be 13.75%. The annual maintenance charge will be $8 on the first payment, $1 on any subsequent payments. There won't be any penalties to withdraw part of your funds. Prudential will also have a "backloaded" annufty that will pay 13% to start. There aren't any sales charges on this type of contract. but there is a penalty of 770 if you withdraw any money in the first year. That penalty scales down gradually until it disappears entirely in the eleventh year. The annual maintenance fee is $25, starting in the second year. Several Insrrrance companies will a& offer variablerate annuities that invest in mutual funds. Northwestern Mutual Life's plan will give buyers the choice of a money-market fund, stock fund or NML I, a fund that will move in and out of various investments "as market conditions warrant," a company spokesman says. This is another backloaded plan. which will charge a penalty of 870 of principal for withdrawals made in the first fiye years. The annual matntenance fee is 530. Reproduced by the Library of Congress, Congressional Research Service with permission of copyright ciairnant * Boston OK, you have decided the new individual retirement accounts (IRA) are a good idea. They save on taxes. They can offer a firm savings program. You can now put aside up to $2.000 a year, even if you are already covered by your company's retirement program. But where should you invest your IRA money? There are banks, savings-and-loan assodations, brokerage houses, mutual funds, insurance companies, and credit unions - all putting on an advertising blitz to pull in as large a share of these accounts a s they can. Much of the money going into IRAs now is probably "old" money simply being shifted from one account to another. Some is "new" savings that will help fill financial institution coffers. The accompanying table shows the six main financial Institutions that are competing for the 40 to 60 million potential IRA customers. The listed products, interest rates, and restrictions for each category are, of necessity, very general. So, wherever you shop for an IRA, here are some possibly useful questions: What is the interest rate? How is it calculated? How often is it compounded? Is the rate guaranteed for a specific length of time? What is the minlmum inltial investment? What is the minimum on subsequent investments? Are there charges to open the account? If so, is this a flat fee or is it a percentage of the deposit? 0 Can I contribute to the IRA through payroll deduction? . 0 Are there any annual charges? 0 Are there any charges to transfer money from one of your accounts to another account, a s from a money fund account to a bond fund? 0 What are withdrawal penalties if vou want to take your money somewhere e!se? Business correspondent of The Christian Science Monitor By Thomas Wattersoo. what to look for in making an IRA kitty \ Here are a few additional points to consider: Your first investment decision need not be your final one. Many institutions have little or no charge for transfer ring or withdrawing your money. The law permits you to .sNft your IRA account once a year to another investment vehicle. You must make the shift within 60 days after withdrawing from the first IRA. Federally insured depository institutions, such a s banks, savlngs-and-loans, and credit unions, probably offer the safest IRA vehicles. particularly for people who don't want to to be. tending their account. The 18- to 3emonth certificates to their offered b v b a n k ~and .WLs are ~ a W j ? .i~c~rirdihg 1210 14 percent Flxed annultles, mutual funds None to $l,ooo Unknown Noneto 8.75% None load 5%to $25. front None, usually None None None None None,but m e commissions $15 $3 to None None None, to 3 months' interest P/o,drops to none None None interest 6 months interest 6 months pendth ads, from 12 to 15percent interest a t maturity. ,Putmoney Into your IRA account a s q&kly a s you can. If you can afford it, put the entire'$2,000 innow and and start collecting interest immediately. The effect of compounding - especially if it is done daily - means the sooner the money goes into the IRA. the more it will earn. 0 Don't get hung up on the $2,000 figure. Many people a r e saying. "I can't afford to put $2,000 a year in an IRA." They should put in what they ran afford. Even if it is only SO0 (less than $10 a week), that's $500 that is not taxed by Uncle Sam this year and will probably be taxed at a lower rate a t retirement. 5600 $15 to None None to s,1000 11 to 15 percent rot014 percent None to $500 SlDOto s1,m 7to 14 percent 11 to 15 percent Share accounts Certificates: 1arnonth variable lamonth fixed 30month variable $year fixed Certificates and passbodcs, l a to 3(knonthvariable or fixed rates Money market fund Growth stock fund Bond fund Income fund Growth stocks Selfdirected mutual funds Intwd mte(1ssz) The IRA accounts: who has what? By Francine Kiefer Business correspondent of The Christian Science Monitor Boston Think of it, a t age 65 you could retire with a comfy individual retirement account - worth a million dollars. It's right there in print. . .just like the ads say. , The ads are hard to miss. They are put out by banks arross the country. and many run full-page in daily newspapers. Their simple message is this: open an Individual Heti~ementAccount. save $2,000 a year, retire on a million. Is this for real? Yes and no. Mathematically. these millionare ads are accurate. If you pump the maximum allowed !$2.000 if you're single, $ 4 . 0 0 if you're married) into your IRA at the beginning of every year, it will reach the million mark in almost 35 years. The banks arrive at this grand total by figuring a 112 percent rate of return, compounded daily - a reasonable rate in today's economy. But what if that 12 percent rate doesn't stick around for the next 35 years? And will $1 million still be worth $1 million in today's purchasing power then? And how easily can people . put $2,00Oor $4,000 aside by the beginning of every year? None of the ads guarantee the 12 percent over the life of the IRA. At Dry Dock Savings Bank in New York, which runs full-page "millionare" ads in the New York Times. Joseph Ludovico says the bank guarantees 12 percent interest for 18 months. Mr. Ludovico, pension services manager for the bank, says the 12 percent rate works out to nearly 13 percent because of the daily compounding. "I feel uncomfortable about the ads," says Barnet Berin, director of program standards at William M. Mercer Inc., a major pension employer benefit firm. Berin says 12 percent is "very Mgh" and can't be counted on to continue. "Over the long run, interest rates have been well below 12 percent," he adds. It would be much better, he suggests, "if the ads showed what would happen at low, medium, and high rates." Interest rates make a big difference in the end sum. Let's say the IRA was figured on 8 percent instead of 12 percent. same rules still applying. What might have been a nest egg of , $2,131.620 after 40 years would come down to $612.380, says Michael Ryan, principal and actuary a t Towers, Perrin, Forster & Crosby, another pension consulting firm. L, Kenneth McLennan, an economist with the Committee for Economic Development, says the "retire a millionare" campaign is "a little optimistic." He adds: "As the prime lending rate begins to fall substantially in the next 5 years, banks simply will not make it [the $1 million goall " Of course, it's debatahle whtlher the rates will fall a s Mr. MacLennan predicts. But, he says, if the prime rate doesn't fall and stays where it is (around 15 percent), the 12 percent rate of return will hang on . . . and so will high inflation. And that means $1 million will not be worth $I million in 1982 purchasing power a couple decades down the pike. If we assumed a 10 percent rate of inflation over the next 25 years. $1 million would be worth $58,820 in today's dollars. However, "this country's democracy couldn't last through so many years of high inflation," Mercer's Mr Rrrin suggests. Mark Clark. a spokesman for the United States League of Savings Associations. says that what the "millionare" ads do is force people to recognize that "self-managed retirement plans can result in a significant nest egg for everyone. It shows people how fast tax-free, compounded interest can accumulate.'' If you're in the 50 percent tax bracket, Mr. Clark says, tax-free IRA accumuhtion over 35 years will be nearly 10 times more than if it were taxed. There's still the question of how many people will be able to put aside that maximum amount for their IRA every year. Manv* ~. e o. o l will e be ooenine an IRA in addition to their own . employee pension plan. Barnet Berin says, "people under the social-security wage base 1$32.4001would have problems saving it." ~ i c h a e Ryan l thinks it will be done "by people . . . whose family expenses (mortgage, car, etc.] have subsided." Dry Dock's Mr. Ludovico disagrees. He emphatically states that "people wanting to carve a niche for themselves will be able to do it." The incentive is in the extraordinary accumulation of interest. he exclaims. Taking a cold, hard look at the million-dollar IRA .