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The compound solution to saving? The IRA

Workers can stash up to $2,000 in an individual retirement account each year. And tax-deferred compounding can turn thousands of dollars into hundreds of thousands of dollars over time.

Personal Finance editor


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© St. Petersburg Times, published February 20, 2000

SEMINOLE -- Retirement is still a long way off for the Rohrmann brothers. But Pierce, 24, and Adam, 23, have taken a step toward paying for it -- with a boost from their dad.

Instead of the usual gifts last Christmas, George Rohrmann gave each of his sons $2,000 to open their first Roth IRAs.

"I felt like I needed to give them a kick start," said George, 51, a social worker at the VA Medical Center at Bay Pines. "They just weren't thinking about it."

They are now, and so are millions of other workers who are making this a big IRA season for many mutual fund companies, which offer IRAs.

"If your funds are performing well, you're taking a lot of new cash in this year on the IRA side," said William Galvin, senior vice president of operations at Denver-based Invesco Funds Group. "Our IRA contributions are running about 30 percent higher than last year, which was only up 5 percent from the year before."

No matter what other retirement plans you have, almost any worker who earns at least $2,000 can stash that amount in an individual retirement account each year. Those who make less can contribute their entire earned incomes, and non-working spouses of wage earners are eligible to make contributions, too.

For young workers short on cash, the money to make contributions often comes from a parent or grandparent who appreciates the magic of compounding investment returns. A $2,000-a-year contribution earning a 10 percent average annual return over 40 years will produce an account worth more than $885,000. If returns are higher or a child starts very young, multimillion-dollar balances are possible. Minors can have IRAs managed by a parent as long as the child has earned income.

All IRAs offer tax-deferred compounding -- in other words, you don't pay taxes on the interest as it grows -- for as long as the money stays inside the account. Some varieties have additional tax benefits, but not everybody is eligible. (For a review of the requirements, see 2H.)

The Roth IRA, which Rohrmann recommended to his sons, is the best alternative for most workers who qualify. Although you cannot deduct the contributions from your taxes as you make them, you don't ever have to pay taxes on your investment earnings if you follow the rules. That's a great deal, especially for young workers such as Pierce and Adam, who began working while students at Seminole High School.

Pierce, who now lives in New York City, just started a job traveling the world selling Repechage skin care products to spas. He calls it his dream job, but says some day he might like to have his own business. He also knows he isn't likely to earn the kind of pension his dad will have as a long-term government employee.

"Most people in my industry change jobs every six months," Pierce said. But he said he knows nothing about investing for retirement. "I can talk about skin care, but I haven't a clue about anything financial."

He invested his $2,000 gift in the TIAA Growth Equity Fund at his father's recommendation. George said he knew about TIAA, which stands for Teachers Insurance and Annuity Association, through his wife Pauline's career in education. Although the funds initially were sold to teachers, they are now open to all investors.

Any IRA contribution made by April 17 can be recorded as a 1999 contribution, and that's what Pierce did with his gift. Now he is making contributions for 2000 from his own earnings through automatic transfers from his checking account.

Unlike his older brother, Adam has a keen interest in investing, which has been amplified by his job as a trading assistant at Raymond James & Associates Inc.'s St. Petersburg headquarters. Processing orders to buy and sell mutual funds, he has been impressed by the large sums some clients have accumulated in their IRAs.

"Now I'm obsessed with investing," he said. "I'd invest everything I make if I could."

Unwilling to go along with his dad's advice for his IRA, Adam called more than a half-dozen mutual fund companies and requested information about their technology funds. He has fund investments in a taxable account, but at last word, he was still mulling over how to set up his IRA.

"My sons are different from one another in every way," George Rohrmann said, "and this holds true for their investment strategies."

But in their preference for mutual funds, the Rohrmanns have plenty of company. Mutual funds held 44 percent of the $2.1-trillion in IRA assets at the end of 1998, according to statistics compiled by the Investment Company Institute. The second-most popular IRA vehicle was a self-directed brokerage account invested in stocks or bonds. Banks and thrifts, which once had the largest share of IRA assets, had dropped to about 12 percent.

Stock market gains are the main source of growth in IRA accounts, followed by rollovers from employer-sponsored retirement plans. Still, workers have been setting aside $8-billion to $9-billion a year in new IRA contributions during the 1990s, according to the Employee Benefit Research Institute.

One in four U.S. households owns a traditional IRA, and about 7 percent own a Roth IRA, even though the Roth just made its debut in 1998. At Baltimore-based T. Rowe Price Funds, about a fourth of the new IRAs being established are Roth accounts.

When the Roth IRA was created, Congress gave owners of traditional IRAs the option of converting to Roths. The big catch: They have to pay taxes on the money being withdrawn from the traditional IRA. That attracted an initial flurry of interest, fed partly by the fact that people who converted in 1998 could spread the taxes over four years. Since that deal ended, conversions have fallen dramatically.

"Our total for 1999 conversions was half of our monthly average for 1998," said John Barth, principal for the retirement services group at the Vanguard Funds, near Valley Forge, Pa.

But conversions still may make sense for people who have the money to pay the taxes from sources other than the IRA. Conversion is most appropriate for people who are in lower tax brackets than they expect to be in after retirement, such as young people just starting their careers. Conversions also allow an IRA to remain intact as an inheritance for children or grandchildren because minimum distributions are not required at any age.

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