Individual Retirement Accounts: Why bother?
by William K.
Thesis: When planning for retirement, Individual Retirement Accounts offer several benefits; however, careful planning is essential to
ensure that: upon retirement there is an adequate amount of money saved, that the heirs to the IRA are chosen carefully, and that
unnecessary taxes and penalties are avoided.
I. Upon retirement there is an adequate amount of money saved.
A. How much money necessary to retire?
1. Social Security verses retirement.
2. Savings Accounts verses retirement.
3. Advantages of starting an IRA early.
II. Careful selection of the heirs to the Individual Retirement Account.
A. Advantage of leaving IRA to spouse
1. Special rights as a spouse.
2. Different options the spouse has for claiming money.
III. Avoiding unnecessary taxes and penalties.
1. Recoverable trust as beneficiary.
2. Taking money out before the age of 59 1/2.
3. Penalties for leaving money in too long.
Many people often live their lives without considering how they plan to retire. People do not realize that the idea of living solely on the
benefits of social security is not realistic. In order to secure a comfortable future, people must have some type of additional income.
Sacrificing a small amount of money into an IRA at a relatively early age could make a considerable difference in the lives of people
upon retirement. When planning for retirement, Individual Retirement Accounts offer several benefits; however, careful planning is
essential to ensure that: upon retirement there is an adequate amount of money saved, that the heirs to the IRA are chosen carefully, and
that unnecessary taxes and penalties are avoided.
It is important to consider how much money will be needed for a comfortable retirement. Careful planning is essential when considering
an item with such importance. Phaneuf states that, according to figures used by most financial planners, upon retirement the average
person will need roughly seventy percent of their current income to continue living their present lifestyles (94). With only income from
Social Security and money saved in bank accounts, most people are unable to achieve this goal. Furthermore, one must also consider, for
a retirement account to be effective the account has to maintain interest rates above that of inflation. Inflation increases approximately
four percent annually; and standard bank accounts barely beat this rate. In fact, at present, most savings accounts have an interest rate
below four percent. Thus, regular savings accounts are not a practical method to save for retirement; however, IRA's offer deferred taxes
on the interest earned until the money is withdrawn from the account. Therefore for a given amount of money, there is a considerable
advantage when saving in an IRA. For example, according to Heady:
if you were to save $2000 dollars a year at 6% for 30 years under the terms of a regular savings account, the total earnings would be
approximately $120,900 after paying taxes; however, if you were to shelter $2000 a year at 6% in an Individual Retirement Account that
amount would increase by $48,000 dollars to a total of $168,000 because of the tax-deferred feature (60).
Using this example, the tax deferred feature of an IRA is easily recognized as having a considerable edge over regular savings plans.
Another advantage to consider when planning an IRA is to start the account as early in life as possible. It is obviously an advantage to
use the program that is going to give the best overall return; however, the advantage of starting early should not be taken lightly either.
As with all savings plans, a key factor in the final results is the overall length of time that has been exhausted investing into the account.
People often think that there is an age requirement to start an IRA; however, this is not the case. There are several Banks that will even
allow teenagers under the age of eighteen to begin an IRA, as long as their parents cosign. The results of starting as a teenager are
astonishing. According to Spears:
if a 15-year-old were to begin saving $2,000 a year in an IRA for ten years and earns 10% a year, the compounded annual return on the
Poor's 500-stock index for the past 60 years. Barring early withdrawals, that $20,000 investment would be worth more that $1.5 million at
age 65 (55).
It is easy to see that the earlier the account is started, the more interest eared over the years on the account, and the more financial
stability that will be established at retirement. In addition, starting early also allows the holder to start off investing less money; thus
taking off some of the burden of having to invest larger amounts of money into the IRA at later ages. Keep in mind, "This is a small
price to pay to gain financial security for the rest of your life."
There are also several items that must be determined when establishing an IRA. Among the most important, is careful selection of the
beneficiaries. When leaving assets to a spouse, things are very simple because the spouse has special rights as an IRA beneficiary. For
example, a spouse that has reached the age of 59 1/2 and wants to utilize the money in the account can remain as a beneficiary. By
leaving the account under the name of the deceased, the spouse can begin withdrawing the money as a life-time allotment. The spouse
also has the option of taking the money out over the next five years following the original IRA owner's death.
Rowland states that the other alternative is for the spouse to convert the IRA to his or her own name. Under these terms all of the regular
IRA rules will apply. The spouse will then be able to change all conditions under which the original IRA was opened. For example the
beneficiaries can be changed, money can continue to be invested into the account, and the spouse may select different mutual funds if so
desired (59). The disadvantage of this method is that unless the spouse wants to pay a ten percent penalty, the money will be locked
under IRA terms until the he/she reaches the age of 59 1/2. Generally if the money is left to the spouse, under normal circumstances and
provided he/she outlives the original holder, most of the major penalties should be avoided.
In addition, when opening an Individual Retirement Account one should become very familiar with the rules and regulations. Many
people leave their IRA practically untouched only to have their heirs lose the majority of it to taxes and penalties; however, if you
understand the rules, most of these penalties can be avoided. To avoid paying these incredibly large taxes to the Internal Revenue Service
(IRS), there are a few items one should understand. For example, when an IRA is left to someone other than a spouse, the rules change
significantly. According to Rowland, If the IRA holder were to make the unfortunate mistake of changing the beneficiary to a revocable
trust, the penalties are caustic. Immediately following the death of the original holder, the IRA will cease to exist. Thus causing federal
and state taxes to be due immediately on the "entire" amount in the account (59). Therefore, If the IRA were to have two million dollars
in the account, using the normal income tax rate of thirty percent, the value could shrink down to as little as $1,400,000. A $600,000
penalty that could have been avoided. By leaving the account to a or child, the IRA could have continued to exist "tax deferred" for
several generations; this strategy would also avoid the income taxes that would otherwise be outstanding on the account.
. Additionally if you take money out before the age of 59 1/2 you will receive a ten percent penalty on top of the regular income taxes.
IRA's were designed as a means to save for "retirement," therefore, to avoid this penalty, simply leave the money until after retirement.
Sanders states that from the age of 59 1/2 to 70 1/2 "You may withdraw as much as you like or nothing, and pay only the usual income
taxes (unless the withdrawals are so large you owe a 15% savings penalty)" (202). It is a good idea to leave the money in an IRA for as
long as possible; however, Sanders further explains:
that there are also penalties for leaving the money in too long. When the holder reaches the age of 70 1/2 he or she must begin making
annual withdrawals. Except for the first year, for which you get a three month grace period, the deadline for each years minimum
withdrawal is Dec 31. So if you turn 70 1/2 on June 30, you must make a 1995 withdrawal by April 1, 1996, as well as a 1996 withdrawal
by Dec, 31 1996. Withdrawing less than required in any year will cause a 50% penalty on the amount of the shortage (202).
It is significantly important to stay educated about all of the possible penalties and keep track of all significant dates. The "small print"
could actually cost up to several thousands of dollars in needless penalties, and the only one responsible for this knowledge is the IRA
An Individual Retirement Account is a program that should be considered by all families. As long as careful planing is done, the heirs
are chosen carefully and care is taken to avoid the taxes and penalties, most will find that IRA's are excellent for planning retirement.
Families growing in the nineties must begin to look to the future and decide if the plan that they have established is sufficient to leave
them financially stable for the rest of their lives. The cost of living is far above the level of when one could plan to retire solely on the
benefits of Social Security. As times pass, many major companies are beginning to no longer offer the type of benefits that once could
support a family after retirement. Therefore, It is a must that we start taking the steps necessary to ensure our own futures are filled with
the dreams and livelihood we all desire.
Heady, Christy. "Your complete guide to tax-free income." Consumer Digest
Nov-Dec. 1995: 22.
---. "How to retire with financial security." Consumer Digest. Sept-Oct. 1995: 60.
Phaneuf, Anne M. "Start saving before it's too late (retirement savings)."
Sales and Marketing Management April. 1996: 94.
Rowland, Mary. "With big IRA's a wrong move can be costly." Nations Business
Dec. 1995: 59.
Saunders, Laura. "Endgame (IRA account management; includes related articles
on taxation of such accounts)." Forbes 19 June.1995: 202.
Spears, Gregory. "Making kid stuff out of IRA's