Some savers who continue to make contributions to an Individual Retirement Account, even though they cannot take a tax deduction, stand to get as much back at retirement as they do under current law because they will be in a lower tax bracket, according to a study released yesterday by the Employee Benefit Research Institute.
In analyzing provisions of the bill passed last week by the Senate Finance Committee, the nonprofit organization also found that most persons who expect to take their IRA money out before retirement would do better financially by investing in tax-exempt municipal bonds.
The committee voted to eliminate tax deductions for IRA contributions for those covered by another pension plan, or about three-quarters of the 28 million American households now participating. Those with another pension plan could make after-tax contributions of $2,000 a year ($4,000 for a joint return; $1,250 for a spousal IRA) and allow the interest to accumulate tax-free. The measure is calculated to save $25.5 billion in tax revenue over five years.
Surveys have shown that the majority of IRA contributors are looking for immediate tax breaks rather than retirement saving. The research group did not attempt to estimate how many people would stop funding an IRA if they cannot get a tax deduction, but the number is believed to be substantial.
A potential decrease in the future of the IRA market, which now amounts to about $250 billion, has prompted the savings institutions, mutual funds and others that hold a large portion of it to try to preserve the tax incentive.
A tax lawyer for the Investment Company Institute, the trade group for mutual funds, took exception to the research group's report. Catherine Heron said that tax-deferred IRAs are a better deal financially because the investors get to invest more of their money, resulting from the tax deduction, rather than giving it to the government up front.
Several measures to save the popular deduction are expected to be introduced on the Senate floor. Sen. Alfonse D'Amato (R-N.Y.) proposes to pay for keeping the IRA by delaying the indexing of taxes for one or two years. And Sen. Robert J. Dole (R-Kan.) yesterday mentioned dropping some real estate tax breaks to keep IRAs. Other means of accomplishing this are expected to be debated on the floor.
The research group, which is known to be more sympathetic toward employer-sponsored tax-deferred savings plans such as the 401(k), said the taxpayer in the current maximum bracket (50 percent) would come out ahead putting after-tax money into an IRA for 30 years, even though contributions are not tax-deductible. For example, $1,000 invested at 10 percent compound interest for 30 years equals $8,725 when taxes are paid at the 50 percent rate. A nondeductible contribution of $730 ($1,000 minus 27 percent paid in taxes) would equal $9,496, or 9 percent more.
These results would not be true if the taxpayer in the top bracket today were to drop to a lower 38 percent bracket under current law at retirement. In this scenario, the after-tax value of an IRA would be larger after 15 years under current law.
For persons in the current 25 percent tax bracket, there would be less difference. Compared with current law, the IRA contributions made under the Senate bill and left in until age 59 1/2 would be slightly more valuable up to 20 years and slightly less valuable after 30 years.