It may be too late for New Year’s resolutions and too early for tax preparation, but investors don’t have to wait for spring to dust up their individual retirement accounts.
Since investors have until April 17 to make qualifying IRA contributions for 1994, this two-month grace period is an ideal time to revisit investment strategies formulated years ago and clean up accounts cluttered by years of neglect.
All too often, investors open an IRA and make regular contributions, only to let the account mildew with age. The matter is no small one: By the end of 1993, some $857 billion had been entrusted to IRAs in the last two decades.
Congress created IRAs in 1974 to boost the nation’s pool of savings and encourage workers not covered by a company pension plan to create their own. As an incentive, it made IRA contributions tax deductible and IRA savings tax deferred until taken out at retirement or penalized for early withdrawal.
Originally, anyone with a job could reduce the annual tax bill by putting $2,000 a year into an IRA and deducting it from the adjusted gross income. But when generous tax breaks appeared to be cutting into federal revenue, Congress made IRAs less attractive to investors already covered by a pension plan.
Reforms under the Tax Reform Act of 1986 limit full or partial tax-deductible contributions only to workers without a company plan, individuals who are covered but earn less than $35,000 a year and married couples covered by a plan but earning less than $50,000 a year.
Savers with incomes above those thresholds can still contribute as much as $2,000 a year to their IRAs and get the benefits of tax-deferred growth, but the contributions won’t lower that year’s taxes.
Tax laws aren’t the only things that change every year, so financial advisers recommend investors make IRA housecleaning an annual rite.
– Clean out low-return investments. Since the whole point of a retirement account is to build up as large a portfolio as possible by the time your boss hands you a gold watch, IRA holders ought to take larger risks, investment advisers said, and that means more stock investments. Because losses in IRA accounts aren’t tax deductible and losses in taxable accounts are, IRA money often ends up in low-risk, low-return investments. While it’s true that stocks can be volatile investments in the short term, investors socking money away for retirement need to look as much as 40 years ahead.
Tax-deferred investing “enables one to take a long-term view, and with so-so returns in so many markets last year, investors have forgotten about a long-term view,” said Thomas Livergood, a 38-year-old financial planner at Harris Bank in Chicago who keeps 100 percent of his own retirement money in stocks.
Since 1926, stocks have returned 4.56 percent a year after inflation and taxes, outperforming bonds and cash savings. “People get seduced by the guarantee,” said Joan Gruber, a certified financial planner, who calls low-risk certificates of deposit known as CDs “Certain Death” for retirement planning.
For returns that will last for the 20- or 30-year retirements this long-lived generation will likely enjoy, no one who’s working can afford to have less than half an IRA’s portfolio in stocks, Gruber said. “If they could emotionally handle the risk,” she said, “I’d go as high as 60 to 70 percent.”
– Schedule contributions for brighter returns. Procrastinators with ready cash should avoid the perfectly legal practice of making last year’s IRA contribution on the day before taxes are due in the current year (normally April 15, but extended through the Easter weekend, to April 17, this year).
Even if it means doubling up with 1994’s contribution, investors should make 1995’s contribution now to get an extra 15 months of tax-deferred performance. “You want to make your contribution as soon as possible to get a few more ticks on the clock,” said Mark Dow, a tax partner at Coopers & Lybrand.
Look at the numbers: Assuming 8 percent annual returns, $2,000 contributions made on Dec. 31 of each year for 20 years would result in a total accumulation of $91,525. The same annual contributions, each made one year earlier on Jan. 1, would return about $7,300 more at 8 percent annual returns, resulting in a total accumulation of $98,850 after 20 years.
– Keep non-deductible contributions separate. Younger investors who are not eligible for a tax deduction should still contribute the maximum $2,000 each year for an IRA’s tax deferment. “It’ll grow tax deferred for 30 years,” said Stuart Kessler, senior tax partner at Goldstein Golub Kessler, who doesn’t recommend the practice to investors over 60.
Complex IRA withdrawal rules dictate that non-deductible contributions should be kept segregated from past years’ deductible contributions. When retirement arrives a few decades from now, withdrawals will be taxed differently if the IRA contains non-deductible contributions, which are reported on a special tax form each year they’re made.
– Dust off list of beneficiaries. Divorced investors often keep former spouses as their IRA beneficiaries through sheer neglect, financial planners said. A simple form available from the IRA’s maintaining institution lets investors change primary and secondary beneficiaries at any time.
– A place for every account; every account in its place. IRAs are often spread out over several accounts at different financial institutions. Concentrating money in fewer accounts instead of spreading it around translates into fewer dollars spent on annual maintenance fees that can run as high as $50 per account.
Combining accounts even from disparate institutions should be a simple matter. Investors don’t even need to contact their old money managers; just call the firm where the accounts will be consolidated and ask for an IRA transfer form to fill out.
Workers who leave an employer’s 401(k) retirement plan can keep the proceeds tax-deferred by rolling them over to their IRAs within 60 days of the last day on the job.
After accounts are consolidated, there are fewer monthly statements to track.
– Don’t make a mess of your future. Even if proposed congressional legislation one day allows it, investors shouldn’t tap IRA accounts for college tuition or first-time home purchases. With the age for Social Security eligibility likely to rise to 70 and the oldest Baby Boomers nearing 50 this year, IRA money should be resisted at all cost.
“I’m a little leery about people putting away money for retirement and then dipping into it in 5 to 10 years,” said Coopers & Lybrand’s Dow. “You end up hurting yourself in the long run.”
