Even Politicians Hear Cry for IRAs : Renewed Tax Break Could Spur Saving

Who says Washington isn’t listening? Recognizing that most Americans have a real need to save for retirement, the Senate Finance Committee has voted to expand eligibility for individual retirement accounts--extending tax breaks to great numbers of wage earners for whom Social Security will provide less than 35% of current income for the allegedly golden years.

To be sure, politics may doom the idea for this year. The full Senate takes up the tax bill today amid controversy over enterprise zones and other questions. And if the bill passes, the new IRA must survive a House-Senate conference and a threatened presidential veto.

Still, political analysts say there’s a new attitude in Washington that favors tax incentives for personal saving--a sharp contrast from congressional sentiment in the 1986 Tax Reform Act that curtailed tax deductions for retirement saving.

The outlook now is for the next Congress to renew eligibility for almost all taxpayers to deduct $2,000 a year from taxable income, put it in an IRA and earn tax-deferred income until near-retirement age--a significant spur for investment.

And not a moment too soon. Even though everyone can earn tax-deferred income in an IRA account, and many employees are still eligible to make tax-deductible IRA contributions, retirement saving has been lagging.

Which defies statistical probabilities and good sense. On the one hand, average life expectancy after retirement is now up to 18 years for men and more than 21 years for women. On the other hand, most people will need extra money because Social Security will provide roughly a third of the income they earn at work.

A 40-year-old today, who will earn $42,000 a year before retirement, can look forward to $15,000 a year from Social Security. Lower incomes will earn a higher percentage--a 50-year-old earning $20,000 can hope for about $10,000 a year in retirement.

And higher incomes will get a lower percentage from Social Security--a 45-year-old, who eventually earns $65,000 a year at work, will get 28% or $17,892 a year in retirement.

For a comfortable retirement, you’ll need a lot more. The Washington-based Employee Benefits Research Institute estimates you’ll need 75% of pre-retirement income to live well. Even if that sounds high, most people think they’ll need 60% or so. Retirement, after all, should not be a time of penury and nervous tension.

To achieve those comfort levels, saving is necessary. And these days saving means investing in stocks, bonds and mutual funds, because the 3% available in bank accounts amounts to literally nothing after taxes and inflation.

That’s where IRA accounts come in. Because they allow investment income to compound tax-free for years, even decades, they can bring your nest egg the “miracle” of compound interest--meaning if your money earns 6% a year, it doubles in 12 years, and if it earns 8%, it doubles in nine.

The return, of course, depends on what kind of investment you put into the IRA. And prudence dictates that you have several accounts, some with stocks, others with fixed-income securities, says Robert Pozen, general counsel for Fidelity Investments, the mutual fund group.

Authoritative figures bear him out. Ibbotson Associates of Chicago has been measuring investment returns since 1926, and its tables show that over the last 20 or 25 years stocks of companies both large and small have earned roughly 11% to 15% a year, handily outperforming long-term corporate and government bonds which have returned 9% or less.

But in the last five years, long-term bonds have earned about 11% a year compared to 9.7% for stocks of large corporations and only 3.7% for stocks of small companies.

Which tells you clearly that nothing is permanent or predictable. So you should spread your investments to build up a cushion for retirement.

Why should the government give you a tax break to save for a comfortable retirement? For all sorts of public policy reasons. A high level of personal savings provides capital for industry. At the very least, an increase in savings would make it easier to finance, and perhaps to start reducing, the government deficit.

And it’s time to change our ways. For more than a decade, Americans have been saving below historic rates--5% of disposable income where they used to save 7% to 8%. That’s much less than other countries--citizens of Japan and Germany put away 16% to 20% of their incomes. But for decades Americans could say their real retirement saving lay in the rising equity in their homes.

In the ‘90s it’s a fair question whether that home equity will continue rising. Meanwhile, the need for retirement savings grows urgent. All members of the vast Baby Boom generation of the 1950s are now in their 30s, and many are in their 40s. If they’re only starting to save now, they should be putting away 17% to 20% of their income, say retirement experts.

Recognizing that need, the Senate today considers expanding tax breaks for retirement accounts, as attitudes have shifted to favoring inducements for personal saving. Clearly, even Washington listens sometimes.

Don’t Keep Retirement Eggs In One Basket.

With Social Security expected to provide less than 40% of Americans’ current income, investing for retiremement is a necessity. And diversity is prudent. Stocks have returned more than bonds over 20 years, but in the last five years the opposite has been true.

Total Return (in percent) S&P; 500

Over 5 Years: 9.74% Over 10 Years:18.48 Over 20 Years:11.51% Small Stocks

Over 5 Yrs: 3.73 Over 10 Yrs: 13.03 Over 20 Yrs: 14.29 Long-Term Corporate Bonds Over 5 Yrs: 11.55 Over 10 Yrs: 15.89 Over 20 Yrs: 9.46 Long-Term Government Bonds Over 5 Yrs: 10.78 Over 10 Yrs: 14.93 Over 20 Yrs: 8.95 Source: Ibbotson Associates