Taxes: Saving Yourself

In the wake of President Reagan's monstrous tax increase, we'd all better start thinking hard about the future and how to save ourselves from the economic disaster that both Republicans and Democrats seem equally eager to inflict upon us all. Which brings us to a subject I've never discussed in this column before: Individual Retirement Accounts.

Now we all know that the Social Security system is bankrupt. And we further know that right now it takes two or three working Americans to support each individual currently on Social Security. And we even further know that as the baby boom generation matures, that ratio could deteriorate to one worker supporting one Social Security recipient. Which means Social Security or freedom in America or both just might die.

The alternative is each of us looking out right now for what's going to happen in our old age. And the IRA, as it's called in the trade, is the vehicle to do that.

Now in the past, most savvy financial advisors steered their people away from IRAs. There were much larger returns to be had in "hard money" investments. In addition, IRAs have in the past been ringed about with a wealth of destructive rules and regulations that made them not worth the effort—you couldn't have one if you were already covered under any other pension program; a "nonworking" individual (read: "housewife") wasn't eligible for an IRA; the maximum you could deposit in any one year was $1,500.

When IRAs were introduced in the early '70s, they were a sop tossed to the banks, whose reserves were being decimated by government policies that militated against saving (and still do, for that matter), thus destroying capital pools from which the whole standard of living comes. So big deal: you could stick a deductible $1,500 in a bank account each year and earn 7 percent (if the bank was a high-flyer), while inflation raged along at double-digit rates. On top of which you can't take your money out of such an account before you're at least 59½ without paying normal (high) income tax rates on it, plus a whopping 10 percent penalty tax. Thanks, guys, but no thanks. That's why IRAs were dogs for most of the '70s.

Now, however, things have changed a bit. First of all, it's become generally known that you don't have to stick the money into a bank and make that whopping 7 percent interest. You can put it into money market instruments, money market funds, stocks, bonds, etc. And get this: you can self-direct such an account; that is, you say precisely what investments your retirement stash is put into.

Before the Economic Recovery Tax Act of 1981, many smart people were going wild pulling it in by getting into "hard" investments: gold, silver, commodities, art, antiques, precious gems, strategic metals…you name it. So naturally, such investments for IRAs were outlawed as of 1982. But you can invest in a wealth of other areas, not just bank accounts and annuities and such, and you can direct those investments yourself. Very important.

In addition, as of 1982, courtesy of the big tax revision in 1981, everyone—whether covered by an existing pension program or not—can have an IRA. Also, the yearly limit, which only has to be put in the account by April 15 of the following year, has been raised to a slightly more respectable $2,000 ($4,000 if both spouses work and have their own IRAs). And so-called nonworking spouses can have IRAs (that provision has been in some time now, but the limit for those types of IRAs has also been raised).

It all boils down to this: you can save money now and pay lower income tax rates on it when you're an old geezer and have less income, or you can split it with the government today and enjoy what's left over. Not much choice there, really.

Now, I can't tell you all about IRAs in this column. Contact a stock brokerage house; they all have their own IRA setups. And buy a tax book or visit the library and read up on them. Here, in the meantime, are some tips for the smart people:

• Be sure your IRA plan is "self-directed." Everyone seems to be saying today that the stock market is tremendously undervalued. They're right. If supply-side economics manages to triumph after all, we could see another '60s-style boom; watch for many stocks to skyrocket.

• If you're a hard-money person (who isn't these days?), you can partially circumvent the anti-hard-money rules by investing in hard-investment stocks, like gold and silver mining stocks.

• If you have a nonworking spouse, the limit for both IRAs (yours and your "spousal" IRA) is $2,250. If you each work and have your own IRA, the yearly limit is $4,000. Everybody get a job. Like, perhaps, you pay your wife, formally and following all the employer/employee or independent-contractor rules, for work she does for you during the year. If she makes $2,000 as an employee, she can put $2,000 for that year into her own IRA (this may or may not ultimately work; it's the kind of thing the IRS will jump on as soon as it becomes widespread; but on the other hand, I haven't seen any cases saying it can't be done and see no reason why it shouldn't).

• For those of you with kids just out on their own, starting to make money but getting killed by income taxes, give them a gift each year of $2,000 (tax-free to both sides) for their IRAs. Better yet, shift income away from yourself (thus saving money on taxes yourself) by giving them an interest-free loan that will generate $2,000 per year in interest for them. You've gotten rid of an extra $2,000 in interest each year that you would have had to pay taxes on (usually at around 40 percent or 50 percent), and they pay no taxes on the interest they earned because that $2,000 goes right into their IRA and is thus deducted from income on their tax returns.

Finally, remember that you can put money into your IRA all the way up to April 15 the following year. Thus, when tax time rolls around (extensions count, too), you can figure right there in cold, hard cash how much such an investment will save you. Can't beat that.

Now go do it. Save yourself from Social Security that isn't.

Tim Condon is an attorney and a tax specialist practicing in Florida.