Data on Annual Interest Rates Is a Convenience
Q: Recently, you discussed the interest rates and annual yields advertised by banks and savings and loans, and it sparked another question in my mind. When the account term is less than one year, why is an annual yield advertised? It seems misleading. --J.L.
A: According to representatives of the thrift industry, the yields of accounts of less than 12 months maturity are “annualized”--as it is termed--to make it easier for customers to compare rates. Why is this done? Because there are now no other commonly accepted methods of advertising and comparing investment rates. Further, and perhaps more important, thrifts are required by federal law to post only annualized yields to help customers compare various investment opportunities, regardless of whether the accounts are for a year, more than a year or less than a year. In case you want to check, the regulation that covers this is 563.27 of Title 12 of the Code of Federal Regulations.
Is the practice of annualizing yields misleading when it’s applied to accounts of less than a year? That’s a matter of some debate. Clearly, a $1,000 certificate of deposit with an compounded daily, annualized yield of 6% earns less in six months than it would if invested for a full year. By our accountant’s reckoning, the difference is 93 cents--all due to daily interest compounding. You get six months more of daily compounded interest during a full one-year investment term than you would with a six-month account.
Q: A few months ago, another columnist in the paper talked about the number of scholarships available for entering college freshmen. Are there any sources listing those scholarships and how to apply for them? --P. M.
A: Your local library’s reference section should have several books about college scholarships available for your perusal. Among the best, reports Riverside high school counselor Connie Decker, are: “Resource Guide to College Student Financial Aid” and “Federal Educational and Scholarship Funding Guide,” both published by Grayco Publishing. She also recommends “How and Where to Get Scholarships and Financial Aid for College” published by Arco Publishing.
By the way, Decker cautions her students and their families not to fall for mail-order solicitations offering to create a list of potential college scholarships tailor-made for your high school senior. These businesses, which often charge upwards of $50 for their services, simply do what parents and school guidance counselors can do for themselves--for free and usually better.
Decker notes that the most successful scholarship seekers are those qualified students whose parents make the application process a family project. And don’t let your family’s income stand in the way of seeking scholarships, she adds. Many scholarships are given out as recognition for high achievement and are not based on financial need.
Q: Earlier this year, my wife and I sold about $12,000 in stock from our individual retirement accounts to help purchase a new home. I know we will have to pay taxes on this money as well as a penalty for early withdrawal. But I don’t know how this will get reported to the government and what I must do. Can you help? --F.E.A.
A: Actually, the process is not much more complicated than filling out your annual tax form and writing a check. Your broker will send you a 1099 Form, noting that you sold the stock from your IRA and the amount you received from the sale. A copy of this is sent to the Internal Revenue Service and the tax collection authority for the state in which you reside; in California, it’s the Franchise Tax Board.
In preparing your federal tax return, you should complete Form 5329 to report that you owe a penalty for a premature distribution from your IRA. For your state tax return, be sure to complete and file Form 3805P. You do not have to file the 1099 form that your broker sends you; this is an informational form only.
Another important issue to consider when making a premature withdrawal from an IRA is withholding tax. If your broker or IRA trustee does not withhold any taxes from your distribution, you could face an additional penalty from the state and federal government for failing to prepay sufficient taxes on your income for the year.
State and federal penalties are assessed when taxpayers fail to prepay either 90% of the taxes they will owe for the year or an amount equal to their tax obligation for the previous year.
If taxes were not withheld from your IRA withdrawal, our tax experts say you can make up for this and avoid a potential tax penalty by increasing the amount of taxes you have withheld from your paychecks between now and the end of the year.
Although the taxes may not have been withheld in the same quarter as the IRA withdrawal was made, the government overlooks this and accepts a final-quarter prepayment as though it was made any time during the year. (Unfortunately, this does not work for individuals filing estimated tax returns. In these cases, the taxes must be prepaid in the quarter in which the income is received.)
Although prepaying additional taxes now is bound to cut into your income for the remainder of the year, and could be especially constraining during the holiday shopping season, the alternative could be a stiff tax penalty. And you should try to avoid that at all costs, especially since you are already paying a 10% penalty for withdrawing your IRA funds early.
