The Ecphorizer

Individual Retirement Accounts-Fooled Again!
John DeRose

Issue #23 (July 1983)

How to throw your money away

Smart people aren't necessarily foolish, but they too have "gut" feelings and a sometimes irrational "common sense."

So what happens? They believe they will retire with over one million dollars (or maybe $500,000)

Your net is then $2,690 on a $10,000 withdrawal!

- and forget that money you can spend is very different from an accountant's entry, even if he's a CPA! They sign up for an account that the bank says will reach a million dollars, and they just give a quick glance at the small print that says it is only insured for $100,000, and very large headlines speak of bank failures and thefts every day.

[quoteright]Can everyone be fooling themselves ("all of the people, some of the time")? A bank that has a million-dollar account insured for only $100,000 is doing business as usual. A government that backs welfare, Social Security and life-time income taxes is certainly consistent in promoting IRAs. An individual who doesn't read the footnotes can still see a big picture, even if he misses some of the details.

You can ony blame yourself, you can only fool yourself, if you bought the big picture and missed the details. Is this what you thought you were buying...

Retirement money "when you normally will be in a lower tax bracket": Did you miss the point that you couldn't possibly be in a lower tax bracket if you withdraw hundreds of thousands of dollars from your IRA?

Pay less taxes: You pay more tax dollars, not just because you earn more, but because your tax rate is higher. Did you miss the point that a withdrawal from your IRA is added to your other earnings?  So it is likely that you will go into a higher rate. In other words, you could pay more taxes when you finally withdraw and you will pay that higher rate on all of your earnings at that time.

Lower tax bracket: The highest rate is now 50%, but it was just recently 70%. If you are not now at the 50% rate, maybe you are lucky. However, if you take the big bucks later, you will probably go into the highest rate at that time. So you can either pay now, at your rate, or maybe look at $120,000 in your account (for example) and then see it turn into $36,000, and that's after 30 years "investing". (Yes, the interest gives you more, but who knows what the real rate will be, and what about State and Local taxes?).

Your "account": This is where you really get to see some big numbers. This is also where you see projections based on the 12-13% of a year ago, not the 8-9% that is more current, and certainly not a guaranteed rate for the next 30 or 40 years. Did you miss the point that your account has no real guarantees, but you made some? Besides the taxes that will come due, you either maintain your account or face voided interest, various penalties of 6% or 10% or 15%, [Note:  See Letter to Editor in Issue 24. - TW, 2006] and possible bank fees or even government scheduling of your withdrawals (both when and how much you may withdraw). If you still think the money is yours did you really think about it? Forget about 30 years for the moment, and think about just 10 years from now. How's your mortgage then, or how's your business going, or are the kids ready for college? It could be that you just may want only $10,000 back from that big IRA account. After all, last year you put in $4,000, your account says you have $82,949, and you want just $10,000 of it.

Make the $10,000 withdrawal, and your account goes down by $10,640 (because some of the interest gets voided). Then, you could owe an additional $6,670 to IRS (because of the tax rate and penalty). Your net is then $2,690 on a $10,000 withdrawal!! -- and that doesn't include additional State or local taxes or bank fees to be paid.

On the other hand, since you can't use your IRA to borrow against or as collateral for a loan (did you miss that?), and you don't want to pay penalties for early withdrawals, maybe you think you can wait it out for 30 years and end up with more than a million dollars. (A figure actually quoted is $1,307,880).

If you really believe the million dollars, then every year, for the next 30 years, you must believe all of the following:

Your money won't be affected by either thefts or bankruptcies.
Tax laws and rates will be a "favorable" as they are now.
Interest rates will always be high.
You will always have the money to deposit.
You will never find a better investment.

If you are not fooling yourself, okay. On the other hand, if you are now putting in $4,000 a year, just the penalty (not the taxes) will cost you $400 for each of those years, if you choose to get out right now. The longer you wait, the more you pay - unless, of course, you still think an IRA isn't fooling you.

If you are just a little unsure, think of it as a reading quiz. I would also recommend getting a copy of "The Real Report on IRA's - What They Didn't Tell You" from DOR Associates, GPO Box A912, New York, NY 10116 (it costs $4.25). In any case, when you're laying out money, remember: if in doubt, don't! 

New Yorker John DeRose is a management consultant and "financial adviser to 'little' people."  Before wrestling with the national economy, he was a judo instructor.

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