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New Options for Saving in IRAs

Nonworking spouse can save $2,000 a year tax free; Congress plans more change

The individual retirement account may soon be the "comeback kid" of the investment world.

Starting this year, nonworking spouses can contribute as much money as their working partners into an IRA. Through last year, a one-wage couple could make a maximum tax-deferred contribution of $2,250 into two IRAs. As of Jan. 1, such a couple can kick in $4,000, or $2,000 each.

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Moreover, several bills in Congress would expand the IRA concept more dramatically. Among the proposals:

* Allowing people who have employer-based retirement plans to make tax-free IRA contributions.

* Penalty-free withdrawals to pay for college, a first home, or a jobless period.

* "IRA plus" accounts, where income you contribute is taxed but earnings are not.

Back in the 1970s and early '80s, IRAs were considered the centerpiece of nonpension retirement plans: Thousands of people put money into IRAs. Investors would receive an immediate tax deduction on their contributions. And taxes on earnings would be deferred until the earnings were withdrawn, presumably after a person had retired.

These benefits are still available. But with tax changes in the mid-1980s, many Americans suddenly found they could no longer qualify for the full tax deferral on contributions.

Currently, to qualify for a full tax deduction, you cannot be an active participant in an employer-maintained retirement plan. Also, your adjusted gross income must not exceed $40,000 for a joint tax return or $25,000 for an individual return. (Persons with income above those limits may be able to take a partial deduction; but the deduction is totally lost at $50,000 for a joint return and $35,000 for individuals.)

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Anyone can open a nondeductible IRA, where you pay taxes on the income you contribute into the account. The advantage: You can defer taxes on earnings in the account until money is withdrawn.

Not surprisingly, the limits on tax deductions caused money flowing into IRAs to drop sharply, from almost $40 billion in 1986 to about $10 billion a year now. Soon, IRAs were exceeded in popularity by employer-sponsored 401(k)-style plans, where employers typically match tax-deferred contributions by workers.

Now, IRAs are finally getting spruced up. The deduction for nonworking spouses may be just the first step.

Last month, legislation was introduced in both the Senate and House to greatly expand IRA benefits. Several proposals are before Congress, including a version backed by the White House. The measure with the most bipartisan support is pushed by Sens. William Roth (R) of Delaware and John Breaux (D) of Louisiana. This measure is called the "Super IRA" bill.

The Roth-Breaux bill would allow penalty-free withdrawals for such specific purposes as first-time home buying, college expenses, and living expenses during a period of unemployment. (Penalty-free withdrawals for medical emergencies were approved by Congress in 1996.) It would also eventually eliminate income limits for tax deductibility. Even if you were contributing to a 401(k) plan, you could have a fully deductible IRA. And a nonworking spouse would have full IRA options, even if the working spouse has a pension plan.

The most innovative element in the plan would be called an "IRA plus" - really a reverse IRA. Currently, you can withdraw money from an IRA when you turn 59-1/2. But you must pay a tax on the earned income. Under the "IRA plus," a person could withdraw the earnings without paying any tax at all, provided the account has been open at least five years and the account holder is at least 59-l/2. The only catch: You must use after-tax dollars to make the contributions, thus eliminating the up-front deduction on contributions.

"The increase in the spousal IRA last year is a ... step in the right direction" that may bode well for further reform, says a spokesman for investment firm Scudder, Stevens & Clark, New York.

"We have a good shot [at winning] some form of IRA expansion this year," says Robert Pozen, managing director of Fidelity Investments in Boston. "There's strong bipartisan support."

Still, Mr. Pozen predicts that lawmakers will try to keep the government from losing tax revenue, so changes may be modest ones. He expects nonworking spouses will be "unlinked" from the requirements that they can make tax-free IRA contributions only if their working spouses are not in pension plans.

Lest anyone hasn't noticed, providers of investments for IRAs are now actively courting contributions for tax year 1996. (You can fund an IRA to be deducted on your 1996 taxes through April 15, 1997.) Assets in self-directed brokerage accounts are now believed to be the largest category of IRA accounts. They were valued at $415 billion, or 36 percent of total assets in IRAs at the end of 1995, the last year for which full numbers are available, says the Investment Company Institute, a Washington trade group for mutual funds. (Self-directed accounts can include mutual funds or other investments such as stocks.) Assets directly in mutual funds come in right behind, with $411 billion, or 35 percent of the total. They are followed by commercial banks, with $145 billion, or 12 percent; life insurance companies, with $94 billion, or 8 percent; thrift institutions with $71 billion, or 6 percent; and credit unions, with $33 billion or 3 percent.

One tip: Invest in an IRA as early as possible in a tax year to gain the greatest benefit from growth of interest or capital gains. But your final deadline isn't until April 15 of the following year.

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