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The retirement plans discussed in this chapter-qualified pension plans, individual retirement accounts (IRAs), and tax-sheltered annuities (TSAs)-provide many benefits. The most advantageous feature is that all contributions made to each plan are tax deductible. In addition, these plans provide for tax-free accumulation of assets, so that nothing is taxed until the funds are distributed. With these exceptional tax benefits, financial planners will typically seek conservative investments that provide a realistic yield for such plans. Selecting a conservative vehicle is important because these assets will comprise part of the client’s foundation for retirement. If the foundation is eroded due to the loss of principal or purchasing power, there may not be sufficient time to replace the lost funds. Although planners cannot guarantee the return of principal or yield, they can recommend low-risk investments that minimize potential losses.

The key to selection is long-term growth through steady income or asset appreciation. Consistency in investment performance is more important than sporadically high rates of return.

These plans should not involve investments that produce significant deductions, such as through depreciation or investment tax credits, because the benefits cannot be used in taxdeferred accounts. For example, a $2,000 IRA contribution produces a $2,000 tax deduction. If the IRA is invested in a highly leveraged equipment leasing program, no further deductions, such as for interest expense or depreciation, or any investment tax credits can be taken. Therefore, these additional tax benefits would not be utilized. Ordinarily, high write-off programs produce high risk, which makes them unsuitable for pension plans.

It would also be inapproprite to select investments, such as municipal bonds, that provide tax-free income. There would be no advantage with these types of bonds, because pension plans already accumulate income tax-free. Moreover, the disadvantage in choosing municipal bonds is that the distributions would be taxed. Thus, a traditionally tax-free vehicle would be subject to taxation when the funds are disbursed.

Further, an investment that produces long-term capital gains is not better than one that produces an equal level of ordinary income, because most distributions from pension plans are taxed as ordinary income. (The exceptions are noted later in the chapter.)

The tax advantages as well as the supplemental income they provide at retirement make each of these plans an excellent choice for helping a client reach financial goals. The tax/income combination is rarely surpassed by investments outside of this protective umbrella. Consequently, caution must be exercised in selecting investments that will preserve the client’s assets, as well as provide a reasonable rate of return. Get-rich-quick schemes are not appropriate under this umbrella.

Investments planners may wish to consider in funding pension plans include: government securities, conservative stocks and bonds and real estate mortgages, as well as insurance annuities. The values of these investment vehicles may fluctuate, but these investments minimize the risk of loss.
A final consideration in choosing an investment for the plans discussed is liquidity. A certain portion of the assets should always be in liquid investments. This will cover any distributions that have to be made either prior to or at retirement.

This entry was posted on Saturday, August 19th, 2006 at 7:36 am and is filed under Economy, Employment. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.