Following is another in a series of columns on new rules governing Individual Retirement Accounts.
Last week we mentioned--not very enthusiastically--U.S. Individual Retirement Bonds. If the security of government backing appeals to you, but you would like a higher yield, look to your savings institutions.
Banks, savings and loan associations and many credit unions offer a smorgasbord of savings certificates, including one specifically designed for IRA funds.
IRA certificates are issued for periods of at least 18 months. They pay a floating rate with no government-imposed ceiling, tied to some interest standard like six-month T-bills.
Since there is no legal restriction on the yield, and institutions may offer not only different rates but different compounding periods, you should shop around for the best deal.
(Different compounding periods--like daily, monthly or quarterly--may not be significant for the short term. But over a long haul and for the large sums expected to accumulate in the later years, these minor differences could change the final result substantially.)
You may also use most of the normal certificates of deposit available for various terms and currently offering high yields. Of course, regular savings accounts are available, but at much lower rates of return than you can get on a CD.
Money in a federally chartered savings institution is insured for up to $100,000. If your IRA approaches that ceiling, under the 60-day rollover rule you can transfer a chunk into an IRA at another institution, where it will qualify for federal insurance separately from the first account.
Possible disadvantage with a CD: In addition to the 10 percent tax penalty imposed on a withdrawal before age 59 1/2, there is a bank penalty for premature termination of a CD. Institutions may--but are not required--to waive that CD penalty for early withdrawal after age 59 1/2--so ask what your bank's policy is.
Determination of the maturity date itself can be confusing. In some cases if you add funds to an existing certificate, the maturity date is automatically moved ahead. This is not true of the floating rate certificate--the term is not extended when you make an additional deposit.
If you are making periodic small investments in your IRA, many savings institutions will accumulate the funds in a regular passbook account, at a relatively low rate of interest, until the total reaches the minimum amount needed to buy a CD.
Savings institutions either impose no charge at all or a minimal fee for opening and maintaining an IRA. Federal insurance of funds makes this the preferred route for security-minded investors.
Also quite safe--although not insured by the government--is a deferred annuity, available from most insurance companies. (Many brokerage houses also sell deferred annuities, either for an in-house or associated insurance company or through representation agreements.)
Current yields being offered on deferred annuities are very attractive. But be careful--in most cases that high yield is assured for perhaps one or two years.
Generally the minimum guaranteed rate of return over the life of the annuity is substantially less than the current rate--perhaps as low as 4 or 5 percent. However, it's likely that most companies will continue to pay higher yields than the minimum as long as interest rates remain high.
Because tax on earnings is deferred until withdrawal in any case, a deferred annuity may be a better candidate for investment funds outside the IRA. (But there is no loss of the tax advantage if you include it in your IRA program.)
Insurance annuities generally carry a small annual service fee. In addition there is a load or commission--either charged when you buy the policy or deducted in the form of a penalty if you close the account within a specified period of years after purchase.
At retirement time, the insurance company would love to have you convert your IRA to a lifetime annuity. Although this assures an income you can't outlive, the rate of return is usually lower than you can get elsewhere.
But you can withdraw the entire accumulated amount when you're ready to retire, without tax liability if you roll it over into another IRA within 60 days.
So you can use the deferred annuity as your IRA during the saving years, then shift to another investment with a higher payout when you retire.