DO-IT-YOURSELF RETIREMENT

Do you get that sinking feeling around April 14th of each year that the cards are stacked against you? You’ve checked and rechecked for every conceivable (and a few not so conceivable) deduction and exclusion – to no avail. This annual ordeal of financial flagellation seems to be taking more and more of your income each year. It’s practically impossible to salt even a little away for retirement. What to do?

This tax year your dismal day of reckoning could be very different. In fact it might even be pleasant – if you take advantage of one of the two tax-sheltered retirement plans recently passed by Congress. These tax-sheltered retirement plans are known as “Individual Retirement Account” plans (commonly called IRA’s) and Keogh Act (pronounced key-oh) plans (named after the New York congressman who drafted the bill).*

The basic idea underlying each of these two plans is simple. Congress mandated that the 40 million American workers not covered under any corporate or municipal pension plans (excluding Social Security and Railroad Retirement) should have the right to set up their own plans that would provide future retirement security. When you begin to think about the cash flow aneurysms which Social Security is experiencing, hedging your bets makes good sense.

Individual Retirement Account: A Tax Shelter with Flexibility



To induce people to set up these accounts and become less dependent upon inflation-ravaged Social Security payments, Congress upped the stakes by throwing in a few choice tax benefits. The IRA, designed for employees of firms that don’t provide a pension plan, allows the individual to contribute up to 15% or $1,500 of his earned income, whichever is less, to the IRA. This contribution can then be deducted from the gross income when you go to figure taxable income. This deduction can be taken whether you itemize your deductions or take the standard deduction.

IRA contributions can be put into savings accounts, certificates of deposit, Treasury notes or bills, insurance annuities or endowments, mutual funds, stocks, bonds or just about any other recognized form of “non-speculative” investment. No matter what investment medium you choose, though, neither your IRA contributions nor the income they have accrued is taxable until you retire and begin to withdraw them. Usually at retirement you’ll be in a much lower tax bracket than when you earned these funds; hence, you’ll end up paying fewer taxes on the income you’ve deferred earning. On top of these advantages, your funds will grow at a faster rate in the tax-sheltered environment of an IRA because the interest you’re making is not having 25% (or so) lopped off it each year by Uncle Sam.

By setting up an IRA you’ve reduced your tax burden in three ways: you’ve reduced your gross income by the amount of your IRA contribution and lowered your taxes, you’ve tax-sheltered the income from your investment, and you’ve arranged things so that you’ll likely be taxed at a lower rate when your accumulated funds are distributed to you. In addition to all of these features, you’ve also managed to set up a hefty retirement fund that can insure your future financial independence.

Just how well do these IRA tax shelters translate into real dollar savings? To see how dramatically your funds can grow in the hothouse environment of an IRA tax shelter, take a look at the chart on page 103. Let’s assume that both you and your neighbor earn similar salaries and that each of you puts $1,500 a year into a certificate of deposit paying 6?%. The difference between the two of you is that your neighbor doesn’t pay a 25% tax rate on his IRA sheltered contributions and you do. The first year your neighbor gets to put a whole $1,500 into his IRA; after taxes, you’ve really managed to save only $1,200. After ten years have elapsed, his account is worth around $20,000, but yours has only $14,000. After twenty years he’s saved $58,000, but you have only $36,000. Thirty years later and retirement is drawing near – his CD. is worth $129,000, yours only $73,000, ad nauseam.

You were taxed on this income during your best earning years, precisely the time you’re also in the highest tax brackets. Sure, your neighbor is going to have to pay taxes on this sum when he starts drawing it out, but that won’t be until after retirement, when he’s earning virtually no other income that is considered taxable (like Social Security) and will be in a low tax bracket. The bottom line of this example is that if you intend to save money for retirement, no matter what the amount, then you might just as well reap all the tax benefit an IRA can offer you.

IRA plans also offer a degree of flexibility. If you don’t feel like making a contribution to your own plan, you don’t have to. If you can only manage to contribute four dollars during a lean year, that’s fine, too. There is absolutely no minimum contribution you have to make to your own IRA.

Uncle Sam didn’t want to spoil you with too many tax benefits in one package, so he did place a few restrictions on these plans. You can’t begin withdrawing contributions from your plan until you reach the age of 59 ?. Two other less desirable occurrences that can trigger the distribution of your IRA contributions are your death or total mental or physical disablement. Most people prefer to turn 591/2. If you do die before age 59 ?, your funds are distributed to the beneficiary you’ve named in the plan. When an IRA account is transferred in conjunction with a divorce, there is no tax penalty. Funds may be switched to another person’s name, but they must remain in the account.

While your IRA benefit distribution can begin as early as 59 1/2, it must begin no later than age 70 1/2. If you haven’t begun distributing your IRA nest egg by this time, Uncle Sam steps in and imposes a 50% excise tax on the amount that should have been distributed that year.

There are three other important “no-no’s” concerning IRA’s. You cannot use your IRA account as collateral. Pledging an IRA (or Keogh) account is viewed as premature distribution. The difference, though, between merely removing $2,000 a little early and pledging your account is that the entire balance of a pledged account is considered to have been prematurely distributed. Your penalty is based on the entire balance and not just a little of it. On top of this your plan is usually disqualified by the IRS, making the income on it taxable each year. Also, a plan is disqualified in any given year if a person has so much as one dime put aside in any other retirement plan for his benefit.

Another serious faux pas is to exceed the contribution limit of 15% or $1,500, whichever is less. Let’s assume that you’ve set up your IRA with a bank or insurance company well ahead of the December 31st deadline. If you made $10,000 last year and contributed $2,000 to your IRA, which is $500 over the limit, you have until April 15th to get it out. What happens if you leave that excess $500 contribution lying fallow in your IRA? Bad things! You have to pay an excise tax of 6% for each year you leave it in. The 6% tax, since it is really a penalty, is not itself tax deductible. (Uncle Sam will underwrite your retirement but not your carelessness.) If, however, for some reason you just can’t withdraw this excess contribution by April 15th be sure to request an extension on your due date.

A small businessman who’s not incorporated can even set up IRA’s for his employees. And he can select those employees he prefers to cover (unlike a regular pension plan which must cover all employees). This is accomplished in two ways: first, by raising the employee’s salary by the amount the employer wants to contribute to the IRA. This corporate contribution is reported under “other compensation” and automatically deducted from the paycheck. Second, he may have employees request deductions from their present salaries through a payroll deduction. However, this method does not allow the employer to take advantage of tax deductible contributions to employees.



The Keogh Plan: Available to the Self-employed



If an IRA could be said to have a close financial relative, it would obviously be the Keogh plan. Keogh plans resemble IRA’s in as many respects as they differ. The big difference between these two is that a Keogh permits contributions up to 15% or $7,500 of earned income, whichever is less. (Congress may lessen this difference by increasing the IRA maximum contribution to $2,500.) Keogh plans are available to those who are self-employed. People who have incorporated their self-employed businesses are not eligible, unless they incorporated as a small business under Subchapter S of the Internal Revenue code.



The same limitations concerning earned income, premature distribution and excess contributions that apply to the IRA’s apply to Keoghs as well. One important difference: Keogh does allow persons who are covered under a retirement plan at their place of full-time employment to establish a plan for the protection of income earned at a part-time job. One proviso, though, for setting up a Keogh plan for your moonlighting: be sure that the income you seek to shelter is earned income, that is, income you received from your services and not from rentals, dividends, royalties, etc.

The Keogh plan also differs from the IRA in that a self-employed person who sets up a Keogh plan for himself automatically involves his employees as participants. Any employee who has worked for at least three years at a minimum of 1,000 hours per year must be covered by the employer’s plan. An employee who has worked less than this limit can be included into the plan at the employer’s discretion.

The real killer in this law, though, is that the employer is obligated to contribute the same percentage of the employees’ salaries to their plans as he did to his own. In other words, if an internist making $100,000 a year contributes $7,500, which is 7.5% of his Keogh plan, then he has to contribute 7.5% of his nurse’s salary into her own Keogh plan. The contribution must be out of the doctor’s pocket. For this reason one finds that many part-time workers are never allowed to work over twenty hours per week. Another side-effect of this law is that many part-time workers who were racking up 25 to 30 hours per week suddenly found themselves working only 20.

Keogh, unlike IRA, allows the employers to make additional “voluntary contributions.” An employer can decide to make a contribution of 10% of his annual earned income or $2,500, whichever is less, to either his plan or his employees’. This voluntary contribution is above and beyond the 15% or $7,500 rule and is not considered in excess contribution. The voluntary contribution is not deductible, but the interest it earns is sheltered. In theory a person could, by means of a $7,500 voluntary contribution, put $10,000 into his Keogh plan each year.

The Keogh plan allows a person to switch his funds from one employer’s plan to another through a method commonly known as “rollover.” People covered by an employer’s Keogh plan perform all the same rollovers as people covered by IRA’s. A self-employed individual cannot roll over his Keogh funds to another Keogh plan or even another corporate plan; he can only transfer his funds into an IRA. This might cause some real problems if a self-employed person decides he wants to become an employee and wants to transfer his Keogh funds to a corporate pension plan. The best he can do is to transfer his Keogh funds to an IRA or “freeze” his present plan. The whole area of rollovers is a confusing one, and it would be advisable to check with a tax lawyer before attempting one. More limiting still is the fact that a Keogh for a self-employed individual can only be transferred to another IRA once every three years.

Ah, but how much can or should be distributed each year? There are two choices. You can either choose to receive the entire amount of your IRA in one “lump-sum” payment or receive a certain amount each year, based on your life expectancy. In other words, if your IRA has $100,000 in it when you retire at age 60 and your estimated life expectancy is 80, then you must withdraw at least $5,000 per year. You can withdraw more than this if you wish.

If you choose the lump-sum distribution of your funds, you can employ what is called “ten year forward averaging” to spread out and considerably lessen your tax obligation. But unless you plan to have one hell of a spree and use up all the money in that year, you’ll still be faced with the problem of where to put the money so that the interest it gains is not taxed. By opting for the fixed annual amount distribution method, you give your remaining funds the advantage of compounding in a tax-free environment until you need them.

The annuity option is a feature of settlement unique to life insurance companies. An annuity is the opposite of life insurance, since it protects against the risk of living too long. It pays an income that can never be outlived. This resolves the dilemma of an older person who is unwilling to invade his savings account for fear of running out of money. Under an annuity the payout can be increased by using both principal and the interest it earns with no risk. A popular misconception is that the insurance company keeps all the money when an annuitant dies young. This is only for a single life annuity. Many other methods are available involving some form of survivorship rights. Two options are: continued payments to a survivor within a certain period (say ten or 20 years continuation) until all the money paid in has been returned (installment refund), or continuation during the lifetime of the second person (“joint and survivor”).

As you might suspect, income to the annuitant is greater when the survivorship rights are less. Let’s look at how the payout would differ under three typical options when starting with $100,000 with one of the better life insurance companies, using current rates. A single life option would pay $10,908 a year or a total of $174,528 if a 65-year-old man lives to his life expectancy of 81. Under an installment refund, annual income would be $10,152 or $162,432 to life expectancy, with at least $100,000 returned if he dies sooner. If a 65-year-old man elects a joint and one-half survivor option and lives to expectancy while his 65-year-old wife lives to her expectancy of 85, the payout would be $9,636 annually until he dies, and $4,818 for the remainder of her lifetime for a total payout of $173,448. Remember, under any of these plans, income would continue to the annuitant even if he lives past 100.



Choosing Your Investments: From Bonds and Trusts to Hobbies



After setting up an IRA or Keogh, you still have a very rough decision to make – where do you want to invest your funds? This decision is rough because of the latitude you have in choosing an investment medium you can sleep with at nights. Your IRA or Keogh funds can be put into savings accounts, stocks, trust funds, insurance annuities, U.S. retirement bonds or mutual fund shares. If you become dissatisfied with the medium you’ve chosen, you may transfer your funds once every three years.

Where you put your money should depend on how you feel about three key variables: (1) Security – do you require a high degree of security as in a bank account or would a moderately secure investment, like high grade stocks, suffice? (2) Flexibility – do you want to control the direction of your investments actively or are you happy to let somebody else have that problem? (3) Return – what rate of return is acceptable? Is a 5% savings account your cup of tea, or is some speculative go-go stock that might pay 30% more to your liking? There are a multitude of options that can fill just about anyone’s requirements in these areas. Let’s look at just a few of them.

Certificates. One of the safest places to incubate your IRA or Keogh nest egg would be at a bank or Savings & Loan association. The C.D.’s at both of these institutions are insured up to $40,000.

The only problem with an IRA or Keogh plan based on C.D.’s is lack of flexibility. Flexibility is decreased because you must let your money remain in the 7 ?% C.D. for the entire six year term to avoid substantial interest penalties. Careful planning is required to co-ordinate your expected retirement date with the maturation date of the CD. If you decide to retire before your CD. matures, then you won’t collect a full 8.06% in yield. What if you decide to postpone your retirement for a few years? Well, you’ll find that your money has been tied up for another six years. Of course, you can get your money out, but you sacrifice a lot of interest. In all fairness, it should be noted that the banking lobby is trying very hard to get IRA and Keogh accounts exempted from the infamous “Regulation Q,” the law that penalizes early withdrawals from C.D.’s.

To circumvent this problem, some banks are advising their customers to move their retirement funds from high yield, long term C.U.’s to short term, lower yield C.D.’s as they approach the minimum retirement age of 59 1/2. By putting your money into 30-day C. D.’s paying 5 1/2% or one year C.D.’s paying 6%, which are always maturing in rapid succession, you increase the flexibility you have in determining your retirement age.

U.S. Bonds. Your retirement funds can be put into a special type of bond offered by the federal government called “U.S. Retirement Bonds.” These bonds pay only 6% and the interest is compounded only twice a year. Worse still is the fact that they take 20 years to reach maturity. Cashing them in before that time means you won’t even make a full 6%.

Another severe disadvantage to investing in the Retirement Bonds (besides the paltry interest they pay) is the fact that they are not eligible for ten year forward averaging when drawn out in a lump sum fashion. If these bonds were eligible for ten year averaging, you could treat this income as earned over a period of ten years and put yourself into a lower tax bracket. Instead, you must consider this lump sum distribution as “earned” all in one year. Subsequently, the tax bracket you’ll be in could put you into orbit. On the whole these bonds do not represent a very good haven for your IRA or Keogh funds.

Trust Accounts. Most banks in the area offer trust accounts for Keogh plans. Trust-based Keogh plans offer both flexibility and good return. These trust plans allow you to decide the amount of risk you’re willing to accept by giving you a selection of pooled funds you can move your money into. Within the trust pool, one fund might be composed entirely of blue-chip stocks or triple A bonds. Another fund might consist of high yield growth stocks. Still another fund might be dedicated to Treasury notes. Usually you can invest all or part of your money in any or all of these different funds. For a nominal fee you can transfer money from one fund to another as your objective or market conditions change. Unfortunately, these funds only accept Keogh account holders.

Trust funds have their good and bad points also. Their best point is that sometimes they can return a yield anywhere between 10% and 12%. This high return is offset in the first year by the high starting fee you have to pay (anywhere from $50 to $150 and up). After the first year there is usually an annual administration fee of one half of 1% of your plan’s face value.

Mutual Funds. The trust departments of banks can also be used to invest your monies in mutual funds. Mutual funds also offer a significant degree of risk compared to other investments. It’s probably wise to follow Adam Smith’s injunction when considering mutual fund selection, “If you don’t know what you’re doing, then this isn’t the place to find out.”

Insurance. Popular repositories for IRA and Keogh funds are insurance plans which involve a fixed or variable annuity policy. Under a fixed annuity plan, an individual pays a premium each year based upon his age and the amount he wants to receive each month after retirement. These premiums are placed into an IRA or Keogh type insurance policy. At retirement the individual is offered one of two choices. The most unlikely is to choose to receive payments that are calculated to exhaust his account in a fixed amount of time, usually at the end of his estimated life expectancy. The secand option is income for life. Under this plan your monthly payment is reduced a little, but then again, you’re guaranteed monthly income right up until the day you die. It is this income for life feature that makes an insurance-based retirement plan so attractive. A bank has to make sure your funds are exhausted by the end of your estimated life expectancy. If you come from long-lived stock, this type of retirement plan could leave you out in the cold. It’s wise to shop among insurance companies because some tend to charge a huge commission, percentage-wise, during the first few years of your policy. Banks don’t. Each side has its unique features.

Some insurance companies also offer a fixed annuity policy that has a life insurance feature. Plans like these ensure that should the IRA or Keogh consumer die, then the beneficiary will receive either the face value or the cash value of the policy, whichever is more. This plan neatly dovetails the best aspects of IRA and Keogh plans with insurance policies.

Typical Keogh trusts include life insurance policies on the participants. The cash values in these policies would be converted into a monthly income at retirement.

Brokerage Houses. The individual can have almost direct control over the course of his IRA or Keogh investments. Several stock brokerages have agreements under which a bank will act as a financial custodian for a Keogh account. The individual can then direct the broker to buy or sell stocks, bonds, money instruments or what-not, for his account. Arrangements such as these give the individual the maximum amount of flexibility (and responsibility). The yield in these plans is usually proportional to the individual’s expertise in investment.

Unusual Investments. Some experts theorize that your Keogh plan can even put a hobby such as stamp or coin collecting on a tax-deductible basis! Since a ready market exists for both stamps and coins and since it’s so easy to get an accurate appraisal of items in these fields, stamps and coins are considered legitimate investment vehicles. Stamps not only take up a lot less space than a stock certificate, they’re much prettier to boot. (After all, paper is paper, some just collect different types.)

Now, theoretically, you’re ready to put your “hobby” on a tax-deductible basis. Set up your Keogh account and invest in the stamps or coins that will improve your collection. Any outlays you make are just as deductible as a normal cash contribution. Upgrade your collection through trades and new acquisitions, but be sure to keep accurate records of your costs since the commissions you pay dealers and costs of attending conventions for the purposes of improving your collection may also be tax-deductible. There’s nothing like having Uncle Sam subsidizing your hobby, although you’d better check with your CPA before you try it.

In theory there’s no reason why this hobby-based investment idea couldn’t be applied to other areas, like diamonds, gold coins, art, antique guns and antique cars. All of these are good investment vehicles (particularly the antique cars) and have traditionally yielded a tidy return to people know-ledgable in the field. If you possess a solid understanding and interest in any one of these fields, you might want to diversify some of your own retirement funds into these areas. This sort of investment is all right with your own funds, but not with those of your employees. They can sue you if they feel their funds weren’t properly invested.

The whole concept of investing Keogh funds in a hobby is new and relatively unexplored. Before embarking upon such a route, you’d be well advised to consult a lawyer to prevent any future problems. Who knows,someday we might see a lot of Keogh plans based on collections of political buttons, barbed wire or telephone pole insulators.