The Easy Way Out of a Keogh Mess
QUESTION: This business with the new Keogh reporting requirements is crazy. A few years ago I put the grand total of $1,000 in a Keogh because I had some income outside my regular job. I reported the income and Keogh deduction on my regular tax returns for that year. I haven’t contributed to the plan since. So this year my headaches begin. Along with the new Keogh reporting requirements and the impossible form that goes with it, I had to get an employer identification number. Now the coup de grace . Along with my assigned employer ID number, the IRS informs me that I should have filed certain employer forms for the past several years. Considerate organization that it is, the IRS sent the appropriate forms along with a whole bunch of instruction booklets. Because of this mess, I’ve already begun the process of closing out my Keogh. In the meantime, do I really have to fill out this pile of awful forms?--M. B.
ANSWER: If life has any truism besides the inevitability of death and taxes, it is that ignoring the IRS is always very bad advice. And that, in effect, is what you would be doing were you to deep-six the forms. That isn’t to say that you couldn’t make a case for doing so and eventually emerge victorious. But in the meantime you are setting yourself up for months, and possibly years, of grief and harassment courtesy of an IRS computer. Observes Los Angeles tax lawyer James B. C. Barrall, chairman-elect of the tax section of the State Bar of California: “You can’t deal with the service by ignoring it. The notices will get harsher. And once the matter goes to the IRS computer, it is often impossible to get a human being to deal with the problem.”
The alternative in this case seems greatly preferable. Granted, completing and filing IRS forms is drudgery. But considering that you made no contributions in the years between your initial filing and now and that you seem to be saying you had no self-employment income in those intervening years, the procedure is actually quite painless. Just put zeros in the appropriate boxes, sign the returns and send them off. Why should you have to file forms if you had no self-employment income, made no contribution and therefore drew no tax benefit? The IRS takes the view that self-employed persons always have earnings from their business and that it is their duty, therefore, to report it. Hence, you should have been filing the self-employment forms all along--even though all you had to report was that you had nothing to report.
No one ever said that dealing with a Keogh was easy. In fact, they are among the most complex retirement plans around. That is why many sole proprietors, whose self-employment income is limited to a few hundred or thousand dollars picked up by free-lancing or moonlighting, choose to avoid the Keogh--with all of its many attractive features, which include higher contribution levels and more favorable tax treatment than its cousin, the IRA--once they are apprised of its many obligations and complicated reporting requirements. Tax lawyers and accountants say that is more than ever the case now that every Keogh plan--even those with only one participant, as is your situation--has to file a yearly report with the IRS. The required filing of this Form 5500-C also has triggered a rash of Keogh terminations and roll-overs into IRAs, according to these tax specialists.
That is true, they say, even though the IRS points out that most participants in these small plans are not required to complete all of the questions on the complicated form. As the instructions at the top of the form specify, only certain items need to be completed for plans that cover a self-employed individual with no partners or employees.
Your next concerns are time and the matter of what to do with the Keogh money once you close the plan. You only have four days to meet the Sept. 30 deadline for the filing of Form 5500-C if you want to avoid paying late filing fees of $25 a day. (The filing deadline was July 31 but the IRS on Aug. 1 said it will waive the penalties for 1984 forms if they are filed by Sept. 30.)
Closing the plan is a simple matter. You just notify the plan sponsor that you want to have all of the money in the account distributed to you and the plan closed. The sponsor will write you a check. You may then either roll the money over into an IRA, keep the money or combine those two options. (Some taxpayers may also qualify to move the money into a successor plan. Consult a tax specialist before you move the money out of the Keogh if this is an option you wish to consider.) If you choose a roll-over, you have 60 days from the day of distribution to complete it, and you will incur no tax and no penalty. If you want to keep all or part of the money, you will have to pay income taxes on the part you keep.
Whether you also will be penalized for making what amounts to a premature withdrawal depends on whether you are disabled and how old you are. If you are disabled or at least 59 1/2 years old, there is no penalty. (That’s because these are intended as retirement funds, and Congress decided that Americans are realistically of retirement age once they reach 59 1/2.) Those Keogh participants under age 59 1/2 and not disabled will be assessed a penalty equal to 10% of the part of the distribution that they don’t roll over into another qualified retirement plan.
In making your decision, you also will want to determine whether you can lessen your tax burden by using the favorable tax treatment known as 10-year averaging. There are several tests you must meet to be able to qualify for it, chief of which are you cannot roll any part of the distribution into another qualified retirement plan, you must have been in the plan at least five years before the year of distribution and you must be at least 59 1/2 years old, disabled or dead.
Q: I have a very strong hunch that the writer in your column last week who wanted information on how the Rule of 7 helps one estimate how long it takes to double one’s money really meant to ask about the Rule of 72, which is a very good gauge for the layman. Could you pass this rule along to J. T. P.?--J. A. W. S.
A: For J. T. P. and all other Money Talk readers, here is the Rule of 72, which dozens of readers kindly (and some not so kindly) have pointed out is the rule of thumb that last week’s writer obviously had in mind when he mistakenly asked about the Rule of 7. (The latter, by the way, is a legitimate rule but one that apparently is neither as well known nor as useful as the Rule of 72.)
One’s principal will double, this rule states, when the product of the interest rate and the number of years equals 72. (The form of compounding doesn’t alter the numbers to any significant degree, and this is used only as a good estimate anyway.) So, to determine how long it will take your money to double, simply divide 72 by the interest rate. Hence, your money will double in 6.9 years at 10.41%, in 5.5 years at 13% and in 13.1 years at 5.5%.
The beauty of this rule is that it works the other way, too. If you want to double your money in five years and want to know what interest rate you have to have to do that, just divide 72 by five. You will find that you must earn interest of about 14.4% to reach your objective.
As one reader pointed out, the actual answers vary from the Rule of 72 estimates by a mere fraction, and it is easy enough to do in your head that you will look like a wizard when you put it to use at cocktail parties.
