Boston — Since President Reagan signed the tax reform bill, talk about what to do with an individual retirement account has been overshadowed by discussion about who could have an IRA at all. Actually, everyone can still have an IRA, but not everyone can deduct IRA deposits. And anyone who has an IRA - fully deductible or not - still has to decide on the best place to invest the money he has already put in, as well as money he might deposit in the future.
``What you put inside an IRA is largely a function of who the IRA is for,'' says Philip Waxelbaum, national sales manager of Prudential-Bache Securities Inc. ``For instance, common stocks and stock mutual funds fit the bill for younger people who can afford the risks.''
These basic guidelines, of course, aren't really different from before tax reform. But they are being recommended more strongly now, since the people who will be eligible for the full IRA deduction are more likely to need the extra savings when they retire.
The tax law limits the full IRA deduction to people with joint incomes below $40,000. Between $40,000 and $50,000, the deduction is gradually phased out, to be eliminated altogether for joint incomes over $50,000. For singles, the deduction starts to fade at $25,000 and disappears after $35,000. All these figures represent adjusted gross incomes, so you could be earning more and still be eligible after subtracting deductions and credits.
This, the experts say, means the IRA will be used even more by those in more moderate income ranges who, apart from social security, a company pension, and perhaps their home, will not have any other assets to rely on at retirement. For them, a careful, even conservative approach becomes more important.
``The IRA is now a retirement account even more than a shelter for trading,'' Mr. Waxelbaum says. ``I've always been in disagreement with those who saw the IRA more as a shelter for trading than as a savings vehicle.''
Even for those earning more than $50,000, the IRA can still be a useful savings tool. Any money already in the IRA, as well as any deposited in the future, earns interest tax free until retirement, or when the money is withdrawn.
You can get the same benefits outside the IRA, however. ``If you still want to defer taxes, then put the money in a tax-deferred annuity or municipal bonds,'' recommends Jane V. King, a financial planner in Wellesley, Mass. ``You have more flexibility and liquidity than an IRA, and you can put in more than $2,000 a year.''
In response to this, and the continuing interst in IRAs, some insurance companies are expected to market hybrid products, where the first $2,000 would go into an IRA and the rest into an annuity. But you can do the same thing yourself by opening your own IRA, then finding an annuity with no sales charges and low annual fees, preferably under 2 percent.
Apart from eligibility rules, one of the biggest changes in tax reform affecting IRAs concerns capital gains. Before, the tax on long-term capital gains outside an IRA was no more than 20 percent - even less for those below the 50 percent bracket. Thus, people put high-yield investments in IRAs and kept growth investments outside, so price appreciation, which was taxed at the lower capital-gains rate, wasn't wasted in the IRA.
With growth investments in the IRA, any profits on stock sales in the IRA were to be taxed as ordinary income when the money was withdrawn.
Now, with the same tax rate for income and capital gains, it makes sense to put growth stocks in the IRA.
``Before, people did their equity investing outside the IRA,'' says Maynard Engel, a financial planner with E.F. Hutton & Co. ``Now, people are looking at growth vehicles.'' Some people, for instance, may put part of their IRA money in stocks of new companies.
Under the old rules, some mutual fund companies opened funds specifically designed for IRAs. One, Fidelity Investments' Freedom Fund, gave portfolio managers the ability to buy and sell securities as often as they chose, without having to worry about capital gains rules, since in an IRA those rules were irrelevant.
The Freedon Fund will continue to operate, says Gail Eisenkraft, product manager at Fidelity, but it will be oriented toward capital appreciation.
`I think people will get more aggressive'' with their IRA, says Mr. Engel. With lower interest rates and the change in capital gains treatment, people will be taking their money out of certificates of deposit and other money market instruments and moving it to stocks and mutual funds, he says.
They may also try somewhat more exotic investments. When tax reform all but eliminated most tax shelters, it created new opportunities for real estate and other limited partnerships that stressed income, not tax breaks. In the future, moreover, new projects will emphasize income and overall growth potential.
This should make some partnerships useful for IRAs, Engel says.
He thinks it will be some time before CDs, money market funds, or any other vehicles that depend on interest rastes will be attractive for IRAs.
``In 12 months, CDs may be down to 4 percent,'' Engel predicts. ``Will people be satisfied with CDs in their IRAs? I think they won't be. So people will look for high returns. They will be more aggressive.''
For those who have time - like a couple of decades or more - to recoup any losses, a more aggressive posture may be fine. But for those closer to retirement, a strategy of holding gains makes more sense. For them, things like zero coupon bonds backed by the US Treasury - with names like CATS, TIGRS, and LIONS - have consistently paid a very competitive yield with virtually no risk.
``These are extremely conservative,'' Pru-Bache's Waxelbaum says. ``They make a good base for an IRA.''
For a while, at least, people with IRAs will have to be satisfied with the available menu of investing and saving options, Waxelbaum believes. ``There's a lot less impetus for anybody who's creating new investments to create new ones for the IRA market now,'' he says.
But the industry won't ignore IRAs, either, he adds. There's just too much money involved. ``You have five years of built-up savings, rollovers [from other pension plans into IRAs], and the fact that tax-free compounding will keep some new money coming in.''