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Annualizing Investment Yields Makes It Easier for Customers to Compare Rates

June 14, 1998|CARLA LAZZARESCHI

Q: I have noticed that ads in the paper for banks and thrifts use annual yields even when the term of the investment is less than a full year. Why? It doesn't seem quite right.

--T.D.

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A: Yields of accounts whose maturity is less than 12 months are "annualized" to make it easier for customers to compare rates. Why is this done? Because there are no other commonly accepted methods of advertising and comparing investment rates.

Further, and perhaps more important, thrifts are required by federal law to post only annualized yields, to help customers compare various investment opportunities, regardless of whether the accounts are for a year, more than a year or less than a year.

Is the practice of annualizing yields misleading when it's applied to accounts of less than a year? That's a matter of some debate. A $1,000 certificate of deposit advertised as having a compounded daily annualized yield of 4% will, in effect, earn less than that if the term is just six months.

By our accountant's reckoning, the difference on a $1,000 six-month CD is less than $1 because of daily interest compounding. You'd get six months more of daily compounded interest for a full one-year investment term than you would with a six-month certificate.

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Q: If I purchase municipal bonds for my individual retirement account, would the interest on these bonds be exempt from taxes when I withdraw the funds? Also, when I am between ages 59 1/2 and 70 1/2, may I withdraw whatever amount I want from my IRA, or must it be the same amount each year? Finally, once I reach age 70 1/2 and must make mandatory withdrawals, is the required amount a minimum or is it the maximum?

--G.S.

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A: Most investment advisors resoundingly agree that municipal bonds or any other tax-exempt investment are poor choices for your individual retirement account. So, please, don't be fooled by the glib talk of some hustler.

Why should you pay attention to this advice? All withdrawals of previously untaxed money from a traditional IRA are taxable regardless of the type of investment account the funds are in.

So even if the funds are generating what would otherwise be tax-exempt interest, because they are in an IRA, that interest is taxable when the money is withdrawn. You do not want to put your IRA fund into tax-exempt securities--which typically earn lower interest than their taxable counterparts--if those funds will be taxed when you withdraw them.

Taxpayers between ages 59 1/2 and 70 1/2 may withdraw any amounts they want from their IRAs and are taxed on the amount they withdraw. There is neither a minimum nor a maximum amount. At age 70 1/2, you will be required to begin annual withdrawals of a minimum amount. The exact amount of this mandatory withdrawal will depend on the type of distribution you elect to take. In any case, the amount is only a minimum. You may withdraw more if you want, as long as you pay taxes on what you take out.

For more information about IRA withdrawals, you should consult Publication No. 590 from the Internal Revenue Service. To order this pamphlet, call (800) TAX-FORM.

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Q: I am retiring from the federal government at the end of this month. I have been told that because my Social Security benefits will be subject to the "government pension offset," it is likely that any benefits I would be entitled to receive will be negated by the offset. That's fine. My concern is whether my wife, who is not entitled to any Social Security on her own account, will be eligible to draw spousal benefits through me even though I am subject to the offset. What do your experts say?

--F.K.

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A: Your wife will be eligible to claim spousal benefits on your account regardless of whether you collect any yourself. Remember that technically you are eligible to receive benefits and that the offset is the only reason you won't.

Your wife's eligibility for her share of spousal benefits is not affected by the formula that eliminates benefit payments to you.

If your wife begins taking benefits at age 62, she will receive 37.5% of what you were eligible to claim at age 65. If she waits until she turns 65, she could draw the full 50% spousal benefits. As a widow, she would be entitled to full widow's benefits.

By the way, Social Security rules apply equally to men and women. A man can apply for spousal benefits on his wife's account under the same set of rules women do on their husbands' accounts.

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Carla Lazzareschi will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or e-mail carla.lazzareschi@latimes.com.

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