Express IRA teaches how not to invest for retirement

Finding the discipline and wherewithal to save for retirement is tough for everyone, but it’s especially hard for people with modest means and little investing experience.

That made an H&R Block product called Express IRA easy to sell. People who went to the tax-preparation company’s storefront offices for help with their returns could set up these retirement accounts at the same time, often using tax refunds for their initial deposits.

Block calls the accounts a success, helping more than half a million people start saving.

But New York Attorney General Eliot Spitzer last week sued the company for $250 million, accusing it of “fraudulent marketing” and claiming that 85 percent of the customers paid Block more in fees than they earned in these low-interest money market accounts.

Block denied any wrongdoing. But regardless of whether the company broke any laws, its Express IRA is a textbook case of how not to invest for retirement. People with small amounts to invest have many better options, and I’ll mention a few below.

The first red flag: Beware any investment advice from someone who’s not an investing expert – a tax preparer, for instance.

Next, be skeptical about any adviser who steers you to his firm’s products. His bosses may be pressuring him to peddle the house brand even if competitors’ are better.

Finally, when it comes to retirement investing, remember that being overly conservative actually means bearing a lot of risk – the risk that your investments won’t grow enough.

Documents filed with Spitzer’s suit show the Block IRAs were at times paying only about 1 percent interest, which was consistent with the low yields on bank savings at the time. The documents show clients were charged a $15 setup fee, a $15 “recontribution” fee each time they put money in the account and a $10 annual maintenance fee.

With a minimum investment of $300, the first year’s fees would equal 13 percent of an account – 13 times the account’s interest earnings for the year. Obviously, an investor would never make money under these conditions – annual fees would chew away more of the account every year.

But even if it had no fees, a money market account would not pay enough interest to build a retirement nest egg. Money markets are like checking accounts – for parking cash for the short term.

For retirement that’s 10, 20 or 30 years away, investors should emphasize stocks, and amateurs should use stock mutual funds that provide professional management and allow them to spread money among many stocks.

Unfortunately, many mutual fund companies require $2,000 to $3,000 to open an account. Although many have lower requirements for IRAs, even $500 to $1,000 can be steep hurdle for a beginning investor with modest means.

A few funds offer starting minimums of only $250 for IRAs, and you can find them using the fund-searching tool offered by market-data company Morningstar Inc. at its site, www.morningstar.com. But look carefully at the annual fees called “expense ratios,” which are often higher for low-minimum funds.

An alternative is offered by ShareBuilder Corp., an online brokerage at http://www.sharebuilder.com that has no minimum requirement for opening an account and charges only $4 to trade any of thousands of stocks and funds.

There is an annual account fee of $25 for IRAs, which could be quite damaging to a very small account – 10 percent of a $250 account, for instance. So don’t open an account until you had saved $500 or $1,000. To minimize the damage from the $4 trading fee, make subsequent contributions no smaller than $200.

You’ll have a choice of IRAs. The traditional IRA offers qualified investors a tax deduction on contributions, but withdrawals in retirement are taxed as income. The Roth IRA has no up-front deduction, but withdrawals are tax-free.

Although people of modest and low incomes generally qualify for deductions on contributions to traditional IRAs, many pay little or no federal income tax, so the deduction is no benefit. That makes the Roth better, as you wouldn’t face taxes in retirement.

Choosing the best investment is too big a topic for today. But as a starting point take a look at the Standard & Poor’s 500 exchange-traded fund with the ticker symbol IVV. With this, you could match the performance of the broad stock market, which has averaged about 10 percent a year over long periods. And the annual expense ratio is an infinitesimal 0.09 percent.

Jeff Brown is a business columnist for The Philadelphia Inquirer. E-mail him at brownjphillynews.com