Q. A recent article in the Wall Street Journal said that as a result of the GATT agreement, lump sum distributions from qualified pension plans would be significantly lower.   This was the result of pegging the calculation for such distributions to 30 year Treasury bond yields instead of a traditional 5 percent assumption. Is this true, and can those of us vested in such plans expect a lesser lump sum distribution than before?   How significant will the reduction be?

---J.B., Dallas, TX

  

A. Yes, our friends in Washington put a provision in the legislation implementing the world trade pact that affects future retirees who might elect a lump sum distribution. The same legislation also restricted the increase in the maximum contribution an employee can make to a company sponsored 401k plan. In 1995, as in 1994, the maximum contribution will be $9,240. The net effect will be to expose more worker income to taxation and, therefore, increase federal revenues to offset some of the losses from tariff reduction. That's why the change was made.

Under earlier law, the maximum contribution amount would have risen by the annual inflation rate. In the future, it will rise by the annual inflation rate rounded DOWN to the nearest $500 increment. This will slow increases and expose income to taxation.

The defined benefit pension lump sum option is more complicated. In DB pensions, your employer promises to provide a lifetime monthly income based on a formula that uses your salary and years of service. At retirement, some companies offer the option of a lump sum settlement. The amount of the sum, in the past is determined by taking the present value of your estimated lifetime payments at an interest rate of 5 percent. Under the new law, the lump sum amount will be based on the interest rate for 30 year Treasuries, currently nearly 8 percent. Here's how changes in interest rates affect the lump sum paid, assuming a 15 year life expectancy at age 65 and a pension commitment of $1,000 a month:

o             5%                   $126,455 o             6%                  $118,504 o             7%                  $111,256 o             8%                  $104,641 o             9%                    $98,593 o           10%                   $93,057

As you can see, the higher the interest rate, the lower the lump sum payment. While some reports have emphasized that payouts to retirees may be reduced under the new law, it is also a fact that if interest rates are 8 percent, a sum of $104,641 will provide the same amount of lifetime income as $126,455 at 5 percent and that both sums are equal to $1,000 a month for 15 years. The real squeeze here is on the funding of private pension plans.

Is there a message here?

Yes. For all the pious talk from politicians about needing to increase the savings rate, the last fifteen years has been marked by relentless pressure to reduce, limit, or scaleback tax deferred saving in all forms.

  

Q. I am interested in investing in tax-free mutual funds.   Could you provide me with some info on same?   The investment magazines and periodicals are almost void of information on tax-free investments.

---L.B., Dallas, TX

  

A. If you want to go beyond the now routine lists of "best performance in the last month, three months, and year" that appear in the glossy personal finance magazines, I suggest reading the descriptions of the major funds and the "sector overview" in Morningstars' Mutual Fund service. The publication, which costs $395 a year, is available in many public libraries.

A sister publication from Morningstar, Closed End Funds, provides vital coverage of the closed end funds that specialize in tax free bonds. Most of the tax-free bond closed end funds sold at premiums to net asset value per share until last year.   Now most are selling at a discount to net asset value and are worth investors attention.

At year end there were 1550 open end funds that specialized in municipal bonds... 1,325 of them had no potential capital gains distributions because they had an average loss carryforward equal to about 8 percent of their portfolio value. In effect, the loss carryforwards will cover a future capital gain. There are similar carryforwards in many of the closed end funds.

Bottom line: this is a good time to spend some time in the library, researching funds.