THE CONSUMER The Law and the Profits

If you’re not under the wing of a corporate or government pension plan, you probably tell yourself you’ll build your own retirement fund someday. Savings associations know all about folks like you. “We’d still be waiting for those people to come in if Congress hadn’t created Keoghs and IRAs,” says Henry Johnson, of Jefferson Federal Savings and Loan Association in Washington, D.C.

Keoghs and IRAs (Individual Retirement Accounts) offer many people a tax incentive to build a retirement fund. With the average tax bill up 50 percent since 1970, it’s the tax break that attracts people to the plans. “Most people who open Keogh and IRA accounts don’t give a damn about retirement; they aren’t looking ahead,” says Johnson. “The tax break is the thing. They want that shelter here and now.”

Although not technically a shelter – taxes are deferred, not cancelled – Keogh and IRA plans allow you to place a portion of your annual income in a special account without paying income tax on that money. IRA contributors are limited to 15 percent of annual income to a maximum of $1,500 a year; Keogh contributors to 15 percent of income to a maximum of $7,500 a year. The money can be invested in savings accounts, certificates of deposit, stocks, bonds, annuities, or mutual funds. If you find a willing trustee, you can have the money invested in stamps, coins, antique cars, antiques, or paintings.

Earnings from an IRA or Keogh account are untaxed as long as they remain in the account. You pay taxes only on the money you withdraw at retirement, after age 59 1/2. Presumably, your tax bracket will be lower at withdrawal than when the money was earned. Between the deferred income-tax bill and the tax-free compounding of money, Keogh and IRAs are attractive tax breaks.

If they’re so terrific, why doesn’t everyone who’s eligible run out and open one up? Approximately 40 million Americans meet the requirements; only about four million participate. One reason is that many people who qualify for Keoghs and IRAs don’t realize it. To be eligible for an IRA you must be either self-employed or employed but not participating in a qualified company retirement plan, tax-deferred annuity program, or government retirement plan. Even with that fairly clear definition, there is confusion. For instance, a husband and wife who are both self-employed or working for companies without pension plans or profit-sharing coverage may not know that each can set up a separate plan. Also, if a person is covered by a plan at work, his spouse may still set up a plan. If, however, one person has two salaried jobs, and one of those jobs is covered by a pension plan, he cannot set up an IRA for income earned on the second job.

To qualify for a Keogh, you must be self-employed, even if only on a part-time basis. For instance, if you are an accountant for a firm by day and an artist in the evening, money made from sales of your pictures would qualify for Keoghs. Up to 15 percent of your second income – but only of the second income – could be placed in a Keogh account.

IRA accounts are also an option if you work for a company that terminates its pension plan. You can transfer your pension money into an IRA account without paying taxes on it. This rollover option will become more important as an increasing number of small companies terminate pension benefits.

If you are self-employed you can choose between an IRA and a Keogh. With its higher limit – $7,500 versus $1,500 – the Keogh would seem to bea better choice. The catch isthat if you want to set up aKeogh plan for yourself, youalso have to establish Keoghsand make contributions for allyour qualified employees.”People should check the insand outs of opening one of these accounts with their tax attorneys, business lawyers, or accountants,” Johnson suggests. “There may be times when it is not in their best interest, especially if they have employees they don’t particularly want to keep around.” But Paul Abbot of Financial Services notes that, “Sometimes you’d save more in taxes making higher Keogh contributions than you’d lose making employee contributions.”

If one spouse qualifies for an IRA and the other is not employed, a second IRA can be opened for the non-working spouse. The total contribution to the two IRAs is then 15 percent of annual income or $1,750 – whichever is less. The $1,750 has to be split equally between the two IRA accounts. If both you and your spouse are employed, you each can establish an account at the maximum of $1,500 a year.

Congress has before it several bills to raise the level of IRA contributions, but there is considerable doubt that relief is on the way. A Treasury Department official and advisor on tax legislation put it this way: “IRA contributions will be raised over my dead body. With higher IRA contributions you would never find the self-employed opening accounts for their employees. The only way I’d consider raising the IRA contribution is if the self-employed were limited to Keoghs.”

Why else are 36 million Americans missing out on Keoghs and IRAs? For some, they aren’t appropriate. “A young couple earning $12,000 a year would have other priorities and needs for that money,” Abbott points out. “They can’t get at this money without substantial penalty, and at their tax bracket, it isn’t a significant break.”

“Some older people wait until it’s too late. The plans can’t offer the retirement help they need,” adds Al Johnson, a vice president with Investment Company Institute. “It’s really very sad. Those who need it most are least able to afford it.”

The two plans operate in essentially the same way. With an IRA you have until February 1979 to make 1978 contributions; with a Keogh you have until April 15, 1979, or later if you get an extension. The earlier you make your contribution, the better off you are, since the money compounds tax-free from day of deposit. As long as you don’t make a premature withdrawal, you don’t pay taxes on your contributions or the money that is accruing. If you die before age 59 1/2, your estate has access to the money without penalty; if you are disabled before that age, you have access to the money without penalty. Barring those circumstances, you pay a heavy fine if you withdraw your money prematurely: IRS regulations stipulate that you pay income taxes on the money withdrawn plus a 10-percent penalty.

Payouts at retirement vary from plan to plan. Trustees might offer lump sum payments, installment payments, or annuities. Lump sum, for tax purposes, is usually the least advantageous. Keogh plan contributors, however, can use 10-year averaging to dull the tax bite. IRA investors have access to five-year averaging. If you choose lump sum and you die, your estate may have to pay taxes on the lump-sum payment, whereas it won’t if you have arranged for regular installment payouts.

Installment plans are by far the most common way to pay out Keogh and IRA accounts. However, installments must be scheduled to liquidate your account within your expected life span – 80 years old for men, 83 for women.

Keogh and IRA plans may also vary in the service charges levied by the trustee or administrator. Many charge annual fees for managing the accounts; a few charge transaction fees. Some fees are minimal and cover bookkeeping costs; others are horrendous. Abbott says he once met a man who bragged about his great IRA plan. “He told me he paid a one-time fee – equal to the first year’s contribution. I was appalled. That’s the worst case I ever heard. Your first year’s contribution is your most valuable.”

Most savings associations don’t charge fees. Keogh and IRA money will be in their hands far longer than the average savings dollar, so they can afford to forgo bookkeeping charges. “If government regulations become more complicated,” Johnson warns, “we may start to charge a fee. We hope it never comes to that.”

A few plans require periodic minimum contributions and penalize you if the contribution is not made. Under one formula at Jefferson Federal, for instance, you pay a percentage of an employee’s salary as a contribution, and that contribution has to be made even if there is no company income. Under another formula, the employer doesn’t have to make contributions unless there is a profit; without a profit he can’t contribute for himself, either. “That’s the formula most self-employed businessmen select,” Johnson says.

The biggest variable among plans, however, is the method of investment. As with any other investment decision, there are trade-offs. “What you choose has to suit your financial situation and emotional needs,” Al Johnson says. “It’s only money. If an investment makes you uncomfortable, forget it.”

He adds, however, “People have become extra-cautious. But it would be a mistake for somebody in the 25-to-40 age range to be playing it terribly, terribly safe in a Keogh or IRA plan. They should be taking some risk because there’s more reward. The facts suggest that over a 25-year period, you will earn more on investments based on equity and some risk. So if you’re young you should allocate some portion of your Keogh or IRA to risk.”

You can have more than one Keogh or IRA so that your funds can be invested in more than one way. Or you can change your investment vehicle every three years by transferring your account from one trustee (say, a bank) to another (say, a stock brokerage house). If your Keogh or IRA is with a mutual fund company, you can transfer from one type of fund to another without limitation. “Exchange within mutual funds is easier than with any other investment,” Al Johnson points out. “You can swap within the family as often as you want to, and that is a growing advantage. If you decide to be aggressive you can go into equity funds. If you decide to be conservative, you can transfer to money market funds. If you later decide that you were wrong or that times have changed, you can go into equities again.”

If mutual funds have the advantage of flexibility, insurance company annuities have the advantage of long-term payouts – you can’t outlive your assets – and guaranteed minimum rates of return. “An annuity is really a savings plan with an added advantage of lifetime payments,” Abbott says. Annuities now pay close to the interest rate for certificates of deposit, but they also guarantee a minimum of four- to four-and-a-half-percent interest for life. “Banks are paying eight percent today, but they won’t guarantee that rate for more than eight years,” Abbott says.

Abbott adds that some people invest their Keoghs or IRAs in endowments. “If you use an endowment under one of these plans you should have your head examined,” he says. “An endowment policy is a form of life insurance. But it’s a very expensive form. You are locked into contributions. If you don’t pay the premium, the trustees may borrow from cash value to pay your contribution. In 1978 it’s not a good product.”

Stock brokerage houses also set up Keogh and IRA plans. When you invest through your broker, you have the same control over investment decisions as you do with other accounts. You can buy and-sell AT&T at will, but the stock and dividends stay in the account.

The lion’s share of Keogh / IRA money is with savings associations and banks. Today, savings associations offer an eight percent return on funds in certificates of deposit. In the past, if you invested in CDs you had to watch maturity dates as retirement approached because of the penalty for early withdrawal. Recent legislation excused Keogh and IRA investors from this penalty if their plans matured before the CD. They are not excused, however, if they transfer their funds from CDs to stocks or other forms of investment.

Several banks offer plans whereby Keogh and IRA investors can choose among a variety of bank funds and investment vehicles, including CDs, stocks, and bond funds.

Although you may be attracted to a Keogh or IRA plan because of the taxbenefit, you eventually will have a retirement plan on your hands. Before you rejoice over your deductions, choose the appropriate type of account, then shoparound for varieties of investment vehicles, guaranteed rates, service and transaction fees, sales commissions, and methods of payout. Make sure there are no required contributions in any given yearand that you can deposit your money atyour convenience. Check that the financial institution offering the plan will provide you with forms required by the IRSand that it will keep you abreast of newrules – they change constantly.