Elite Benefit Most, Critics Say : IRAs: 'People's Loophole' Under Fire in Tax Debate

Times Staff Writers

When Gene Harte lists his assets available for retirement, he can tick off real estate, stocks, bonds, his graphic-design company and savings--worth more than $1 million in all. But every year before April 15, he makes sure to put $2,250 into his individual retirement account.

"When you're in my tax bracket, you just can't let it go by," the 60-year-old Los Angeles executive said of the convenient IRA tax deduction.

Jeff Chop, on the other hand, really needs an IRA, given that he has no pension and little in savings or investments. But, on an income of $700 a month from two part-time jobs handling photo exhibits and selling fossils, he has nothing left to save. "I need all my money just to get by," the 37-year-old Los Angeles resident said.

Touted as the "people's loophole" and the "little guy's tax shelter," IRAs were made widely available in 1981 as a way to supplement Americans' retirement savings. Since then, they have become one of the most popular investment vehicles in history, with millions of investors seeking not only to save for old age, but to enjoy an extraordinary tax break.

Funds in the accounts have doubled in the last two years. Taxpayers are plowing in as much as $25 billion in the month leading up to April 15, the deadline for 1985 IRA tax deductions.

But the cases of Harte and Chop illustrate a controversial aspect of the program that critics say is cause for reform: IRAs are most used by people who need them the least. Those headed toward an insecure retirement--individuals with little or nothing in pensions, savings or other assets--are much less likely to have them.

There also is sharp disagreement over whether IRAs are achieving their other major social objective, which is to boost the nation's savings rate to promote economic growth and investment. Indeed, the rate of personal savings actually has diminished in the last few years.

Such disputes over the role of IRAs have become a major element of the tax reform debate in Congress. Pending legislation would indirectly limit IRA contributions for many workers. At issue: whether the retirement accounts serve a social purpose that compensates for the lost tax revenues, totaling an estimated $12 billion in 1985 alone.

Used Most by the Wealthy

"Everybody knows they're popular, but are they really great tax policy? A lot of evidence suggests they're not," said an aide to Rep. Pete Stark (D-Oakland), a member of the House Ways and Means Committee, which helped formulate the House tax reform bill.

Data from the Internal Revenue Service clearly shows that "the people's loophole" is most frequently exploited by people who have a lot of money. In 1983 (the latest year for which figures have been tabulated), only one of every 10 households with income between $10,000 and $20,000 bought IRAs. By contrast, almost two of every three earning between $50,000 and $100,000 invested in the accounts.

"I'm really gambling with Uncle Sam's money," said Joan Benson, a 57-year-old Glendale computer programmer who admits that she really does not need an IRA, as she expects to retire with the security of two homes, a generous pension and nearly $100,000 in savings and annuities.

Policy Shift Urged

It may seem only natural that the well-off take greater advantage of such investment opportunities. But some argue that federal policy should be tilted more in favor of those who are least prepared financially for old age.

"IRAs just aren't doing the job. What they are is tax shelters for people who would save anyway," complained Karen Ferguson, director of the Pension Rights Center, a Washington-based nonprofit organization representing workers and retirees.

"The reality is that most people at moderate- or low-income levels can't even begin to think of retirement savings till they're in their 50s--and then it's too little too late," she said.

Despite the criticisms, IRAs have widespread political support. In fact, some congressmen and others recommend expanding the approach to promote savings for health-care expenses, college education and even housing. "IRAs are here to stay," said Alan Fox, legislative representative for banking issues at the Consumer Federation of America.

But IRAs were not always a household word. They were widely overlooked in 1974 when Congress introduced the accounts in an attempt to stimulate retirement savings for workers not covered by pension plans.

IRA Program Takes Off

A key problem was that the many workers who did not stay with one employer long enough to qualify for a pension benefit were left out of the new program. But in 1981, Congress broadened IRA participation to include virtually all workers and to reduce pressure on Social Security. IRA fever was on.

The total amount in such accounts is expected to reach about $250 billion this year and may reach $500 billion by 1990. As many as 45 million individuals own IRAs, with an average balance of about $4,500, said W. Wesley Howard III, publisher of the IRA Reporter, a Cleveland-based newsletter.

It is easy to understand the popularity of the accounts. Unlike many other tax shelters in oil and gas and real estate, IRAs do not require a large investment. Workers may invest up to $2,000 a year, in addition to $250 for non-working spouses.

The funds can be placed in many kinds of investments, including savings accounts, money-market funds, annuities, stocks, bonds, mutual funds and real estate limited partnerships. The investment is tax deductible, and earnings from the investment accumulate tax-free. The funds are taxed only when they are withdrawn.

The catch is that the investment is designed to be long-term. Anyone who taps a fund before reaching age 59 1/2 must pay a 10% penalty, as well as regular income taxes.

Appealing to Elite

Although IRAs are hawked to the masses, their tax treatment clearly makes them most appealing to the elite. Consider an affluent taxpayer in the 50% bracket. For this individual, a $2,000 IRA in effect costs only $1,000 because the other $1,000 would otherwise be paid in taxes. In contrast, the same IRA would cost an investor in the 14% bracket considerably more--$1,720.

"Between paying rent and everything else, it's very difficult to afford one," said Mayda Reyes, 30, a Marina del Rey hair stylist who earns about $14,000 a year and is among the majority of Americans who never have bought an IRA.

Indeed, people such as Reyes, who has no pension benefits, are least likely to purchase the accounts. A March study by the nonprofit Employee Benefit Research Institute in Washington, for example, found that workers already covered by pensions were almost twice as likely as uncovered workers to have IRAs.

IRS figures show an obvious linkage between income levels and the likelihood of purchasing the accounts. Only 2.3% of households reporting less than $10,000 in income claimed an IRA deduction in 1983. This rose to 29.1% for those earning between $30,000 and $40,000 and 82.4% for those earning between $100,000 and $200,000.

Some Have Second Thoughts

"If you've got less than $2,000 in total financial assets, you're going to think very hard before you're going to put in $500 or $1,000 in something that's going to be locked away," said Fox of the consumer federation.

But, clearly, millions of middle-income households have IRAs, even if the money is hard to put aside. "Contrary to what you hear, it isn't just a rich man's gimmick. There are a lot of middle-class people using IRAs," said Julie Domenick Doerr, vice president for legislative affairs at the Investment Company Institute, which represents the mutual fund industry.

Robert Pearson, a 35-year-old San Diego architect who has no pension coverage, says he never has been able to afford an IRA but plans to open a $1,000 account before April 15. "Having no benefits in that regard, I better get one started," said Pearson, a former Canadian who earns about $32,000 a year. "The tax break, of course, is an incentive, but the primary reason would be for retirement."

However, not everybody is convinced of IRA benefits. Some are confused by IRA options and the flurry of advertising from banks, insurance companies, mutual funds and brokerage houses. Others are reluctant to lock up their funds for many years.

Larry Conway, 30, a Pasadena accountant, routinely advises clients to invest in IRAs, but he has yet to start his own. "IRAs are very good, but I'm young enough that I'm reluctant to tie my money up," he said.

Unimpressed by Ads

Others are unimpressed by the avalanche of IRA advertising that seems to reach a crescendo every April. Maribeth Mellin, now an editor of San Diego magazine, said she earned $20,000 in 1985, mostly from free-lance writing, and had little left over. "I'm probably one of those people who should have an IRA," the 36-year-old Mellin said. "I don't have a pension or anything for the future."

But she added that even if she had money to invest, she would rather buy property than a retirement account. "I would have the feeling that I'm giving someone else my money so that they can use it for their benefit. I'd like to have my hands on it instead of someone else's."

In addition to disputes over the merit of IRAs as retirement policy, economists disagree on whether IRA assets represent new savings--or just cash being shifted around.

The Investment Company Institute, a major IRA proponent, contends that the accounts prompted $18 billion in new savings in 1984 and will result in continued increases that benefit the national economy.

Others, however, maintain that much of that money would have been saved anyway. "It's really a shift from one pot of money into another," said Rep. Robert T. Matsui (D-Sacramento), who is also on the Ways and Means Committee.

Information Called Lacking

And others insist that nobody knows the answer, because reliable information simply is not available. "Anyone who claims to have data is absurd," IRA newsletter publisher Howard said.

In light of such uncertainties--and the need to raise tax revenue to cut the federal budget deficit--members of the House and Senate have proposed ways to limit IRAs for workers who also participate in the popular company-sponsored savings programs known as 401(k). Those plans, which are used by about 10 million Americans, allow workers to set aside part of their wages tax-free.

The House already has approved a measure that would reduce a worker's $2,000 IRA limit by $1 for each dollar contributed to a 401(k). In other words, workers who contributed $1,500 to a 401(k) plan would only be able to purchase a $500 IRA. Those who contributed $2,000 or more--presumably the higher-paid employees--would not be able to have any IRA at all. Such a plan would raise about $4.9 billion in new tax revenues over the next five years, the House Ways and Means Committee estimates.

A plan under consideration in the Senate Finance Committee would begin reducing the IRA only after a worker had contributed $5,000 to a 401(k) plan. Each dollar in a 401(k) above $5,000, up to a $7,000 limit, would be one less dollar allowed in an IRA.

Such proposals have IRA proponents up in arms.

Proposals Decried

"If one is going to live in a society where savings are encouraged, it doesn't make sense to couple IRAs with 401(k)s," said Mark Ugoretz, executive director of an industry committee that represents large employers on pension issues. "We think people should be encouraged to put money away and save money--and that money should not be taxed until it ultimately is going to be used."

Other proposals would increase the role that such accounts already play. For example, some government officials, including Health and Human Services Secretary Otis R. Bowen, have recommended establishing IRA-like accounts that would allow workers to save for major health expenses.

Peter J. Ferrara, a Washington attorney and former White House staffer, has proposed a "Super IRA" that would allow higher contributions than current IRAs. Contributors would be able to reduce their contributions to Social Security but would receive fewer benefits as well.

Others have suggested more direct ways to increase the ability of lower-income Americans to participate in IRAs.

One of the most prominent ideas, discussed by congressional staffers and economists, is to make IRA contributions eligible for tax credits instead of tax deductions. Under such a setup, the cash to purchase an IRA would come out of an individual's actual tax payment. Less affluent people then would not have to dip into income or savings to invest in an IRA.

Limits on Deductions

Another idea is to limit the tax deductions from an IRA to, say, 15% of each dollar contributed. That would make the plans considerably less attractive to high-income individuals but probably would not reduce the attractiveness much to lower-income people, who get low deductions anyway.

But, for now, millions of taxpayers are left off the IRA bandwagon.

Jeff Chop, the Los Angeles resident earning $700 a month, said he has studied IRAs offered by various financial institutions. But he added that he would need a better-paying job, ideally in the film industry, before he could make the investment.

"The $2,000 doesn't seem like all that much," he said. "But for me right now, it's really impossible to put away that much in a year."


Adjusted Average size gross Eligible Returns Percent of IRA income returns* with IRAs* taking IRAs payment Less than $10,000 27,992 645 2.30 $1,588 $10,000-$20,000 21,297 2,010 9.44 1,815 $20,000-30,000 14,781 2,945 19.92 2,047 $30,000-40,000 9,814 2,860 29.14 2,379 $40,000-50,000 4,778 2,140 44.79 2,635 $50,000-100,000 3,979 2,558 64.29 2,946 $100,000-200,000 523 431 82.41 2,998 $200,000 or more 164 130 79.27 2,900

* in thousands including joint returns Source: Internal Revenue Service

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