IRAs : Uncertain Rewards : Confusion Over Effects of Tax Reform Hurts Sales of Accounts

The folks at New York’s Manufacturers Hanover Trust, the nation’s fourth-largest bank, started this year optimistic about prospects for sales of individual retirement accounts. They mounted an aggressive advertising campaign, touting their complete IRA product line, ranging from certificates of deposit for conservative investors to mutual funds, stocks and bonds for high rollers.

Consumers, unfortunately, have not totally shared in the optimism.

“We think the market is just not as strong as last year. There’s a lot of confusion in the marketplace,” said Andrea Polinak, head of IRA marketing and investments at Manufacturers Hanover.

Other bankers are also reporting lackluster sales, she said. “People are not as enamored of IRAs as they used to be.”

Lowest Return on Deposits

Consumers’ confusion about whether they are still eligible for IRAs under tax reform, along with unhappiness with the lowest returns on bank deposits in years, is hurting sales of the accounts at some savings institutions, officials at these companies say.

As the peak IRA season enters its final stretch run before the April 15 deadline for 1986 contributions, several major savings institutions in California and nationwide report that IRA sales are decidedly mixed compared to last year.

While some large institutions, such as Wells Fargo Bank, report sales gains, others, such as Home Savings of America, American Savings & Loan and Security Pacific National Bank, report that sales are off from last year. In past years, nearly all major institutions enjoyed strong sales gains.

Even some brokerage firms and mutual fund companies, which generally are reporting strong IRA sales gains due to interest in the stock market, say sales would be better were it not for tax reform.

“There is an awful lot of confusion among investors as to whether they can take 1986 contributions,” said Don Underwood, manager of retirement services for Merrill Lynch, the nation’s largest brokerage.

Although the New York-based company’s sales are up strongly from last year, tax reform “has made IRAs a little less attractive. People are yawning at it more,” Underwood said.

Whether overall IRA sales nationwide this year fall below last year’s remains to be seen.

A last-minute rush of contributions already is beginning to make up for slower-than-expected sales at some institutions, said Sandra W. Tyzbir, manager of institutional trust services at Union Bank in Los Angeles, which acts as trustee for IRA accounts at 650 other savings institutions.

Slower to File Returns

The Internal Revenue Service reports that taxpayers have been slower to file their returns this year, leading some experts to believe that investors have been delaying their IRA contributions as well.

Banking institutions could also pick up some 11th-hour sales from investors worried about a fall in the stock market. Sales also could pick up as some institutions accelerate their advertising and promotion programs.

Many are offering free seminars, videos, toll-free phone numbers, brochures, mailings and other services to explain the effect of tax reform on IRAs. Many banks and savings and loan associations also are offering bonus interest payments, high introductory rates on deposits and discount vacations to lure IRA deposits.

Also, some experts say IRA sales gains at brokerages, mutual funds and insurance companies--whose annuity and life insurance products are gaining favor under tax reform--could make up some or all of the sales declines at savings institutions.

Laura J. Berger, executive director of the No-Load Mutual Fund Assn., estimates that 90% of the nation’s mutual fund companies are reporting IRA sales increases, with some reporting gains more than double of those last year at this time.

James L. Dorsey, editor and publisher of the IRA Reporter, a Cleveland newsletter, expects total IRA sales for all institutions for the 1986 tax year to total between $35 billion and $37 billion this year, about the same as last year, thanks to gains at brokerages and mutual fund companies. IRA assets at the end of 1986 totaled about $290 billion, Dorsey estimated.

Any repeat of last year’s strong sales gain would be an unexpected, but welcome, development for many savings institutions, which feared that tax reform would confuse or discourage many taxpayers from continuing to fund their accounts.

IRAs, which Congress made available to just about all employed persons in 1982, allow workers to deduct up to $2,000 per year ($4,000 for a two-earner couple or $2,250 for a couple with one working spouse).

The funds are invested in accounts that will accumulate earnings tax-deferred until the funds are withdrawn at age 59 1/2 or later (earlier withdrawals carry penalties).

IRA funds can be invested in a variety of investment vehicles, including stocks, bonds, mutual funds, certificates of deposit, money-market funds, U.S. gold bullion coins and certain limited partnerships.

The major source of consumer confusion involves new rules under tax reform that eliminate the deductibility of IRA contributions for certain higher-income taxpayers who participate in a retirement plan through their employer that qualifies for tax benefits under IRS rules.

Taxpayers with such retirement plans filing single returns will lose part of the deduction if their adjusted gross incomes are between $25,000 and $35,000. Single filers above $35,000 will lose it entirely. Taxpayers filing jointly who are covered by retirement plans will begin to lose the deduction if their incomes are between $40,000 and $50,000, and lose it entirely if their incomes are above $50,000.

Taxpayers falling within the income ranges where the deduction phases out can still contribute at least $200 a year to their IRAs on a deductible basis.

Taxpayers losing deductions on IRAs can still contribute to the accounts on a non-deductible basis, however, keeping the advantage of earning income tax-deferred until the funds are withdrawn.

Discourages Contributions

IRAs are less attractive under tax reform for other reasons, too. Lower individual tax rates make the value of the IRA deduction worth less and making the 10% penalty for early withdrawal before age 59 1/2 relatively more painful.

Also, a new rule governing taxation of IRA withdrawals discourages non-deductible contributions. Taxpayers withdrawing IRA funds cannot take out the non-deductible portion first to avoid tax (Non-deductible funds already were taxed before they were placed in the IRA; they cannot be taxed again when withdrawn).

Instead, deductible and non-deductible funds must be withdrawn on a pro-rated basis. That is, if three-fourths of the IRA funds were deducted, three-fourths of any withdrawal will be taxable.

But such changes only affect contributions beginning in the 1987 tax year. Taxpayers can still get full deductions for IRA contributions in the 1986 tax year until April 15.

However, despite extensive publicity and advertising clarifying the new rules, many consumers still erroneously believe that they cannot make deductible contributions for the 1986 tax year, experts say.

Others are confused about whether they can make 1987 contributions on a deductible basis, and that confusion is delaying their 1986 and 1987 contributions. Some consumers, already knowing they are ineligible for deductible contributions in 1987, are simply choosing not to contribute for 1986 as well, experts say.

Even some investment professionals, who should know better, have been confused. Berger, the executive director of the No-Load Mutual Fund Assn., originally thought she was ineligible for a deductible IRA for 1987, because her income, combined with that of her husband, is more than $50,000. However, neither of them has a company retirement plan, so they are still eligible for the full IRA deduction.

Irked by Low Rates

“If I was having such a hard time (figuring out the new rules), a lot of people out there must be just as confused as me,” Berger said.

Adding to the negative sales effect of the confusion is widespread consumer dissatisfaction about low rates offered by savings institutions on CDs for IRAs. This is forcing more institutions to offer mutual funds and self-directed accounts, allowing investors to shift funds among stocks, bonds, mutual funds and other investments.

Banks and S&Ls; had about 50% of total IRA dollars last year, but that figure is down from 77% in 1981 and is expected to fall “significantly” this year, said Alfred P. Johnson, chief economist for the Investment Company Institute, a Washington-based trade group representing the mutual fund industry.

“Banks are basically uncompetitive,” said Gary J. Strum, national product manager for pension services at E. F. Hutton, a New York-based brokerage. “Some banks are touting new, high 6% rates; they should be embarrassed to advertise 6% as a high rate.”

“With low rates it’s hard to be competitive with mutual funds,” said Richard N. Meyer, IRA product manager at Security Pacific National Bank in Los Angeles, which reports that IRA sales are “slightly off” from last year.

In response to fears of losing IRA dollars to marketers of mutual funds and stocks, Stockton-based American Savings, the nation’s largest S&L;, this year began offering a self-directed account of its own. Sales of the account are “gaining momentum,” but IRA sales overall are still off from last year, spokeswoman Dianne Nelson said.

Many savings institutions report that depositors with maturing CDs are placing those funds into stocks or mutual funds. Many mutual fund firms and brokerages are offering to handle investors’ transfers of funds out of banks free of charge, saving the investor the hassle.

Paying Off Big

“The IRA game has changed in banking,” said Robert K. Heady, publisher of Bank Rate Monitor, a North Palm Beach, Fla., newsletter. “Banks once thought they had the IRA customer locked up all the way through retirement. They are now discovering that business can go out the door in a hurry.”

Some banks that are heavily promoting mutual funds are finding sharp payoffs. At Wells Fargo Bank, for example, IRA sales are double last year’s, thanks largely to brisk sales in mutual funds and self-directed accounts, said Lois B. Laine, marketing manager for retirement programs at the San Francisco-based institution.

But sales for the 1987 tax year are expected to decline as tax reform’s restrictions on IRA deductions take full effect.

The Investment Company Institute estimates that of the 28 million households currently owning IRAs, 6 million will lose the entire deduction. The Washington-based Employee Benefit Research Institute estimates that deductible IRA contributions will fall by nearly a third initially, as higher-income people who made the biggest contributions in the past are most likely to lose the deduction.

Some of that decline could be recouped by an expected increase in lump-sum pension distributions placed into IRAs. Tax reform cuts certain favorable tax treatments for pension distributions, increasing the likelihood that recipients of such distributions will roll them over into IRAs rather than face stiffer taxes by taking direct possession of the funds.

People Want Deductions

Still, IRA marketers are concerned that selling the accounts in the future will be tougher and more expensive. It will take considerably more effort to explain to taxpayers losing IRA deductions that the accounts may be still worthwhile because earnings can accumulate on a tax-deferred basis.

“It’s a harder sell,” said Kenneth L. Paine, marketing manager for retirement services at California Federal Savings of Los Angeles, where IRA sales are off slightly from last year. “People are more interested in the federal income tax deduction.”

Some savings institutions consequently have been less aggressive in promoting IRAs, partly because tax reform has made the accounts more difficult to explain and less attractive.

“We just felt there were other areas (to promote) that are potentially more profitable in the long run than IRAs,” said Marci McWilliams, IRA product manager for San Diego-based Home Federal Savings, whose IRA sales are off 60% from last year’s pace.

Home Federal, which last year touted its IRAs heavily through television, radio and newspaper ads, already has discontinued television and newspaper IRAs ads this year and instead is relying primarily on direct mail to current customers. “Our goal is just to retain our existing customers,” McWilliams said.

Instead of emphasizing IRAs in their advertising, many banks are emphasizing home-equity loans, one of the hottest products on the banking scene, newsletter editor Heady said. Other institutions, like Home Federal, are emphasizing first mortgages, given current low home-loan rates.

Some Are Giving Up

Marketers also fear greater bookkeeping and administrative headaches in managing IRAs for those investors who will have both deductible and non-deductible money in their accounts. Although the burden of keeping track of those accounts falls on taxpayers, some institutions such as Merrill Lynch are offering to do it for customers, free of charge.

However, some little banks and S&Ls; are phasing out of the IRA market entirely, discouraged by the added marketing and administrative expense of managing the accounts, said Jerome R. Corsi, senior vice president for Marketing One, a Portland, Ore., firm that consults financial institutions.

IRA marketers also fear greater competition from other retirement-oriented products that were treated more kindly by tax reform. These include single-premium life insurance, tax-deferred annuities and tax-exempt bonds. In response, Shearson Lehman Bros. is among several financial institutions that have developed special non-IRA retirement-savings accounts into which investors can place such tax-advantaged IRA alternatives as annuities and tax-exempt bonds.

Indeed, sales of these alternatives already are picking up, as many financial planners and other advisers are steering clients away from IRA contributions for the 1987 tax year.

Charles C. Mann, president of Professional Financial Advisers, a Mission Viejo, Calif., financial planning firm, said he is recommending that his more sophisticated clients contribute to tax-deferred annuities instead of IRAs for the 1987 tax year. One major advantage of annuities is that they carry no limits on how much a taxpayer can invest, compared to the $2,000 limit for IRA contributions, Mann said.

Paul A. Morin, 40, a Huntington Beach data processing manager, is heeding that advice. While he is making a full $2,000 IRA contribution for 1986, he said he will take money he would have invested in his IRA for 1987 and instead place it in his company’s savings plan and his wife’s tax-deferred annuity.

“I think it stinks,” he said of tax reform’s restrictions on deductible IRA contributions. “I thought the IRA was a great vehicle to help people consider their future. Taking it away is a serious mistake.”

IRA MARKET SHARES

Percentage of IRA funds in different institutions

1981 Mutual funds 9.9% Commercial banks 22.5 Thrifts 54.1 Life insurance companies 12.7 Credit unions 0.8 Self-directed accounts --- 1986 Mutual funds 18.9% Commercial banks 24.1 Thrifts 25.7 Life insurance companies 7.8 Credit unions 6.9 Self-directed accounts* 16.6 * Primarily at brokerages

Source: Investment Company Institute