Question: I wanted to take advantage of the high interest rates on six-month certificates, but I could only come up with about $7,000 in cash. Now I hear there is some kind of loophole that lets people get in with less that $10,000 minimum. Do you know anything about it?
Answer: Sure do -- and it doesn't have a fancy name. In fact, it's called, very logically, a "loophole" certificate. Here's the way it works.
The bank from whom you buy the certificate lends you whatever amount of money you need to make a total of $10,000. It's a six-month loan at their current rate for secured loans, using the ceritficate inself as collateral.
Applying your numbers and using simplified interest rates, the figures work out like this: You borrow the missing $3,000 at, say, 16 percent interest; then with the total of $10,000, you buy a six-month certificate of deposit at perhaps 13 percent.
In the course of the six months you will earn $650 in interest on the certificate. Let's say your tax bracket (combined federal and state) is 32 percent. So the interest income after taxes is $442.
Now how about the loan? At an annual rate of 16 percent, the $3,000 you borrowed will cost you $240. But, assuming you itemize deductions, Uncle Sam and your state will pick up $77 of that, so your net cost comes to $163.
Subracting the after-tax cost of $163 from the after-tax income of $442, you end up with a net of $279. On an annual basis this is equal to an after-tax return on the $7,000 of your own money of just a shade under 8 percent.
That's quite a bit better than the after-tax return of about 4 3/4 percent you could realize on a 7 percent passbook account at a Maryland-chartered savings and loan, and more than double what you would net on most bank or S & L regular savings accounts.
Arranging the loan and purchase of a loophole certificate is relatively easy. But there are alternatives. One you should consider is a money market fund. As I write, these funds are paying better that 16 percent -- equal to almost 11 percent after taxes in our hypothetical case.
The money market funds offer the advantage of liquidity. Your money is available on demand without penalty -- in most cases simply by writing a check, (in some, minimum amount such a $500).
A possible disadvantage is that the rate is not guaranteed. It changes on a daily or weekly basis, pretty much as interest rates in general change.
If you prefer a rate of return that is guaranteed for a six-month period, look into a six-month unit trust. For instance, Corporate Income Fund Series 93, marketed by Merrill Lynch/Bache/Reynolds, was offered on Dec. 30, 1980, to yield 14.8 percent -- equivalent to an after-tax return of 10 percent for a 3i percent taxpayer.
Units in the trust can be bought through any broker at a fixed commission rate which is already considered when calculating the stated yield. Although the units are quoted on a $1,000 basis, your broker may have a purchase minimum. I don't recommend buying less than five units.
There are of course other investment opportunities. But if you want to stay in a relatively safe market in a short-term environment, these three alternatives offer a range of opportunities from which to choose.
Q: I'm 68 years old, retired and drawing Social Security. But I also work part time. Can I have an IRA account based on my extra income?
A: If you are not participating in a company pension plan where you work, then you are eligible for an IRA. You can deposit up to 15 percent of your wages, with a $1,500 ceiling.
The fact that you're drawing Social Society is no bar to either an IRA or Keough. You would qualify even if you were receiving pension payments from your former employer.
But is an IRA a good idea for you? The biggest advantage of an IRA is the tax-shelter aspect. With at least two personal exemptions and your zero tax bracket amount, you are probably paying little or no tax anyway.
And you must start drawing from your IRA by the time you're 70 1/2, at which time all withdrawals are fully taxable. So you can only defer the tax liability a couple of years; the whole thing simply may not be worth bothering with.