Social Security was never intended to be the sole source of retirement income for the elderly. To use a currently popular phrase, it was designed to serve as a "safety net"--a minimal base income upon which workers could build a complete retirement program, using their own savings plus any employers' pension plans available.
With the scope of present benefits under continuing attack, it is increasingly important to supplement potential Social Security payments with a retirement plan of your own.
Fortunately, The Economic Recovery Tax Act of 1981 makes it easier and more attractive for those now working to save for future retirement needs.
The two principal vehicles for constructing your own retirement plan with tax assistance from Uncle Sam are Keogh (also known as HR-10) plans for the self-employed and Individual Retirement Accounts (IRAs), primarily intended for those employed by others.
These two tax-advantaged programs have been around for some years, but starting in 1982 the new tax law increases the annual ceilings for both and opens the IRA doors wide for tens of millions of workers who were previously excluded.
A Keogh retirement plan may be opened and maintained only if you have net income from self-employment. That self-employment may be full-time or part-time; you are eligible even if you have another job in which you are covered by your employer's pension plan (including civil service).
In previous years, including calendar 1981, the amount you could contribute to a Keogh plan was limited by the lesser of $7,500 or 15 percent of your net income from self-employment.
(A special provision permits you to contribute the lesser of $750 or your total net business income if your adjusted gross income doesn't exceed $15,000, without regard to the 15 percent limitation.)
The new law provides a couple of important changes. First, the dollar ceiling is doubled. Beginning in 1982, you may deposit 15 percent of net income from self-employment up to an annual cap of $15,000.
This change is significant, of course, only if your self-employment income runs above $50,000 a year. At and below that figure, the 15 percent ceiling--which is still part of the rules--effectively limits contributions to $7,500 or less anyway.
The second major change benefits practically all self-employed people regardless of the amount of earnings. Starting Jan. 1, you can have an IRA in addition to your Keogh plan, with the same earnings qualifying for both tax-deferred programs.
The Keogh limits are described above. Then you can put up to $2,000 each year into an IRA. There is no percentage limit on contributions to the IRA; the only restriction is that the total of the Keogh and IRA contributions together cannot exceed the amount of your earnings.
If you are self-employed and also work for wages, you can count both sources of income in determining the limit for your IRA. In that situation, you can even have two IRAs--but the combined total of contributions into both cannot exceed the $2,000 annual limit.
Let's say, for example, that you're a civil servant earning $22,000 a year; in addition, you do some television repair work on weekends on which you net another $6,000 in 1982, after expenses.
For calendar year 1982, you will be eligible for a Keogh plan in which you can invest $900 (15 percent of the $6,000 self-employment income).
Then, if you wish, you can contribute $2,000 to an IRA, based on either your self-employment income or your government salary.
That makes a total of $2,900 you can put away for retirement. You get to deduct the entire amount from your income for the year--$2,900 on which you don't pay any income tax until after you retire and start drawing money from the accounts.
The catch, of course, is that it might be difficult to pull out $2,900 from gross income (before taxes) of $28,000 and still have enough to buy groceries.
But it's a good deal if you can swing it, because tax on the earnings accumulating in all the accounts is similarly deferred until you withdraw the money later. So the whole package--annual contributions plus annual compounding earnings--can grow until retirement without current tax liability.
The individual annual ceiling for simplified employe pension (SEP) plans also goes to $15,000 ($100,000 in earnings). An SEP is essentially an IRA to which both employer and employe may contribute; but it is subject to Keogh rather than IRA limits.
How about the IRA changes for people who have earnings only from wages salary or commissions and not from self-employment?
Biggest change: Every employe, whether or not he or she is covered by a pension or retirement plan at work, will qualify next year for an IRA.
The maximum amount you can invest goes up, too. The current (1981) ceiling of $1,500 rises to $2,000 in 1982. And the limit of 15 percent of earnings is wiped out; you will be permitted to contribute to your IRA 100 percent of earnings up to the $2,000 ceiling--a real break for part-time workers.
If your employer maintains a qualified pension, profit-sharing or other retirement plan that is structured to accept voluntary contributions, any such contributions you make qualify as IRA payments.
But neither your compulsory payments to your employer's plan nor your employer's contributions on your behalf will qualify. And the combined total of voluntary payments to the employer's plan and contributions to a separate IRA is limited to the $2,000 ceiling.
The ceiling for a spousal IRA also goes up next year. If you qualify for an IRA and your spouse has no earned income for the year, you can deposit up to $2,250 in two separate accounts--one for you and one for your spouse.
The old requirement that the total contribution be split equally between the two IRAs is eliminated. Next year you will be permitted to divide the $2,250 (or any lesser total) any way you wish--but not more than $2,000 in either single account.
Ownership of the assets in a spousal IRA is vested immediately on deposit. In the event of a later separation or divorce, the working spouse can't reclaim the funds--they belong to the person in whose name the account was opened.
If you are divorced and your former spouse 1) established a spousal IRA in your name at least five years before the divorce and 2) made contributions to that IRA for at least three of the previous five years, you may continue to make contributions and claim a deduction on your tax return.
The annual ceiling in this case will be the lesser of $1,125 or the total of earned income and alimony included in gross income for the year. So even if you have no earnings, you can contribute to the IRA from taxable alimony received from your former spouse.
If you are employed, you are, of course, eligible for your own IRA based on earnings. But the combined contributions to the spousal IRA and your separate IRA cannot exceed the $2,000 ceiling.
With one exception, the normal investment vehicles that were available are still legal for IRAs and Keogh accounts. This includes regular accounts and certificates at savings institutions, retirement annuities from insurance companies, mutual funds, self-directed accounts (at brokerage houses, for example) and federal retirement bonds.
The exception: Starting in 1982, funds may no longer be invested in "collectibles," such as works of art, stamps, coins, gems or antiques. But any such investment made prior to Dec. 31, 1981, may be retained without penalty.
Some of the old rules remain in effect. Withdrawals made from either an IRA or Keogh plan before age 59 1/2 (except in the event of disability) are subject to a penalty. Withdrawals must be initiated not later than the end of the year in which the participant reaches age 70 1/2.
An IRA deduction is allowed for any calendar year if a contribution is made by the due date for filing the tax return for that year. In effect, that means you can establish an IRA and make a contribution by April 15 and still claim the deduction for the preceding year.
Allowable contributions to a Keogh also may be made at any time before April 15 of the following year, but the account must have been established (with at least a token deposit) by Dec. 31.
Contributions do not have to be made on any regular schedule. You can deposit funds early in the year and gain the advantage of tax-deferred earnings right from the start.
If you later determine that you paid in too much, you have until April 15 to withdraw the excess plus any accumulated earnings on that excess and avoid any tax penalty.
(But if you use a certificate of deposit as the investment vehicle, check with your savings institution for possible penalties it may impose on premature withdrawals.)
Your IRA and Keogh funds can be placed in more than one investment medium, although, of course, the annual limits apply to the combined total of all contributions.
You can move the funds around to take advantage of changing economic conditions. If you take physical delivery of the cash or other assets, they must be reinvested within 60 days to avoid tax consequences. And you are limited to one such transaction a year.
But if you simply direct the movement of funds from one trustee to another without actually receiving any of the assets yourself, there is no limit on the number or frequency of transfers.
(This is one of the advantages of using a family of mutual funds for your retirement plan. As market conditions change, you can move part or all of the funds from, say, a growth stock fund to a money market fund by a phone call or letter.)
The message is perhaps clearer now than it has been in the past: Social Security is not intended and should not be expected to serve as an adequate retirement plan in itself.
It must be augmented by private programs.