Two of our greatest fears, taxes and old age, seem particularly pressing these days. The time to "render unto Caesar" is upon us. At the same time, Americans face growing uncertainties about the solvency of the Social Security system, our supposed succor in retirement.
The answer to both worries, according to many people, is Individual Retirement Accounts (IRAs) and Keogh plans (which can be funded for 1982 up until April 15, 1983, if the accounts were established in 1982). The Economic Recovery Tax Act of 1981 made these tax-deferred pension plans much more appealing by raising contribution limits and liberalizing eligibility standards. Since then, thousands of banks, brokers, and insurance companies have deluged the public with advertisements for a diverse array of IRAs and Keoghs.
New books by Jack Egan and William J. Grace, Jr., and a special guide to IRAs published by Money Magazine help clear up the confusion. Both compare types of accounts and provide guidance on which best meet the needs of different investors.
"At a time when it is no longer possible to depend on social security and many private pension plans are also on unsure footing, these personal savings and investment accounts are a virtual must," writes Egan in Your Complete Guide to IRAs and Keoghs (Harper & Row, $13.95). "In effect, the expanded eligibility for IRAs and Keoghs sets up a voluntary second national retirement system that parallels the mandatory but troubled Social Security system."
Somewhat less gushing in his praise, Grace writes in his ABCs of IRAs (Dell Paperbacks, $3.95): "IRAs were never meant to be the answer to your financial worries. But they are an important supplement to retirement planning for most people."
IRAs and Keoghs sound too good to be true. And just maybe they are. Let's be cynical for a minute. The main problem, especially for young people, is that no one knows what the government may do in future years to the tax code and to the value of our money.
IRAs, to which almost anyone can contribute up to $2,000 per year tax-free, and Keoghs, to which self-employed people can contribute up to $15,000 per year in addition to IRA contributions, seem like a marvelous way to build a nice retirement nest egg. Thirty years of maximum contributions compounding at 10 percent per year buys you a $329,000 IRA and a $2,476,000 Keogh. Hence the tantalizing hype of banks, brokers, and insurance companies that we can all become "millionaires." Moreover, you get to deduct your contributions right off the top of your income each year, keep that tax-deferred income working for you, and, so the presumption goes, pay taxes in a lower bracket when it comes time to withdraw that money for your old age.
The big doubt is inflation. It seems to be under control for now, although even a 6 percent inflation rate takes quite a toll over time. Assuming inflation of 6 percent and a 10 percent annual yield, those same 30 years of $2,000 contributions would be worth only $112,000 in today's dollars—only a third of the assumed $329,000 accumulation.
And what if inflation outpaces the yield? If you open a self-directed account with a broker or invest in a mutual fund group, and if your investments don't pay off, you could lose out altogether after inflation.
Even if you're in a savings account at a bank, there is no guarantee that the interest you earn will keep pace with inflation. It wasn't too long ago that a negative real interest rate (the rate of interest minus the inflation rate) was the rule in this country. And there are those in Congress who would like to take us back to those days by forcing the Federal Reserve to hold interest rates artificially low while pumping out inflationary quantities of money.
Along with inflation comes higher taxes under current law. The indexing of the federal income tax due to take effect in 1985 should greatly ameliorate the problem of bracket creep, but again there are those in Congress who would like to repeal indexing. Who knows what future Congresses may do? It's conceivable you could find yourself at retirement in a "millionaire's" tax bracket.
As it is, you must be careful when you start making withdrawals from an IRA or Keogh. As Egan writes, "Your withdrawal schedule should take into account how much you will wind up giving back to the government. With a lump-sum withdrawal, you may wind up giving half of it back in taxes, which will sharply diminish or virtually eliminate years of tax-deferred gains in your account."
Finally, there is the very real threat that Congress will simply change the rules of the game. It might, for instance, decide one day that those trusting souls who had the foresight to build up an IRA or Keogh retirement plan must forfeit the Social Security benefits they've paid for. "There is no predicting what steps Congress will take eventually if the funding situation becomes dire enough," Egan acknowledges.
All that having been said, IRAs and Keoghs are still a pretty good deal. They may just be an offer you can't afford to pass up. But, amid the trumpet blasts of their promoters, surely a little cautionary squeak can't hurt.
Steven Beckner is a financial reporter and columnist for the Washington Times and the author of The Hard Money Book.