QUESTION: One of your columns last spring addressed the differences between state and federal tax law on individual retirement accounts. In it, you mentioned that several bills were making their way through the state Senate and Assembly aimed at making the state standards conform to federal law. Were there any changes that will affect this year's tax returns?--L. K.
ANSWER: No. One of the bills made some progress in the last legislative session, but the California law governing who may contribute to an IRA, and how much, remains unchanged. So, when it comes time to prepare your 1985 state tax return, remember that you don't necessarily qualify for a state IRA deduction just because you're allowed one on your federal return.
Both of the IRA conformity bills that survived the last session of the California Legislature would liberalize the IRA rules, as Congress did with the federal rules in 1981. As proposed in separate bills by Assemblymen Byron D. Sher (D-Palo Alto) and Eric Seastrand (R-Salinas), every working taxpayer would have the right to contribute to a tax-deferred retirement plan--and qualify for a tax deduction of an equal amount on his or her state tax return--even if the taxpayer is already covered by a separate retirement plan at work.
Currently, all taxpayers are entitled to such a deduction on their federal return, but, when it comes time to file their California tax returns, they are prohibited from taking a deduction if they are covered by an employer retirement plan.
The two conformity bills part company over the maximum annual deduction that taxpayers should be allowed. Seastrand argues for a maximum annual deduction at the state level of $2,000 for each individual who works--the same as the federal government allows.
Sher's bill, seeking to appease critics who point out that the state would lose about $400 million in tax revenue in the first year alone if state law adheres strictly to the federal rules, would keep the maximum state deduction at $1,500. It also seeks to further offset the estimated revenue loss by withdrawing a tax deduction now allowed.
As originally proposed, the bill sought to curb deductions for investors in certain "abusive tax shelters." But tough lobbying by the real estate industry and others killed that idea. Sher, whose bill has progressed from the Assembly to the state Senate, is now in the process of finding an acceptable alternative revenue offset.
Most states have already conformed to the federal standards. California lawmakers have balked because of the tax revenue loss.
Q: My husband always took care of our finances, and I was never interested enough to ask any questions. After he died, I had to start handling those matters, so I started asking questions and reading the financial section of newspapers. I often see references to mutual funds and I look at the mutual-fund tables that newspapers regularly publish, and I don't have any idea what a mutual fund is or how to read those tables. Can you explain it so a novice like me can understand?--B. A. K.
A: A mutual fund is a company that pools money from many investors with mutual financial goals and invests the money in such financial securities as stocks, municipal bonds, Treasury bills and certificates of deposit.
This is a good way for investors who don't have the time, the inclination or the financial expertise to analyze and trade individual stocks and bonds on their own to dabble in a broad range of investments and spread their risks. The responsibility for watching the investments and deciding when to buy and sell is delegated to the fund's professional money managers.
If the idea of a mutual fund appeals to you, sit down and have a chat with yourself first. Is your top priority to maximize your current income? Or are you more concerned that your money grows over a longer period--say, 20 years? Maybe your ideal investment strategy is a combination of those two philosophies. You should know the answers to those basic questions before you ever begin the process of selecting a mutual fund, because finding the one that is right for you will hinge on your answer to those questions.
The manager of the mutual fund selects securities that, in his opinion, best match the investment objectives of the fund's investors. That is why it is so important to do business with a fund whose stated objectives match your investment strategy.
Earnings on the money that you entrust to a fund are distributed to you in the form of dividends. They are paid out in proportion to the number of fund shares you own, so you get the same investment return on your dollar regardless of whether you invest a few hundred dollars or several hundred thousand. If securities are sold for a profit, those profits are distributed to fund investors as capital gains.