With excellent reason, most people are wary of committing to an individual Retirement Account funds they may want to be able to tap before retirement. The reason is that to keep hands out of IRA cookie jars the Internal Revenue Service imposes a stiff penalty on any amounts withdrawn before the individual reaches age 59 1/2. The excise tax is a straight 10% of the withdrawn amount on top of ordinary taxes due and is not deductible -- a stricture that effectively encourages saving for one's later years.

But in many cases, putting money into an IRA and taking it out before retirement age provides a good shelter, reduces tax liability for each contribution year, and pays off better than investments made without the shelter. One use, for example, might be to keep cash in an IRA collecting sheltered interest in, say, a money fund, but withdrawing it to sell short common stocks. Short selling (and, in fact, any margined activity) is not permitted in an IRA, but very large returns -- possibly, in aggressive trading, more than 100% -- can quickly be made in a long-lasting, rapidly falling stock market such as occurred in 1981-82. In that event, a knowledgeable investor and naked-option seller feasibly could do better outside the IRA, despite short-term capital gains, income taxes, and the penalty tax.

A similarly unorthodox stance was recently suggested in a personal financial strategies letter sent to clients of Arthur Young & Co., the accounting firm. It is understandable that a person may not want to tie up funds until retirement. But, claims the letter's author, Gary M. Soffer, a tax principal in Arthur Young's Chicago office, investing in an IRA can be worthwhile, even if funds are left in for only a few years. In the table shown, Arthur Young documents the powerful deferment aspect of an IRA. The table assumes the annual maximum $2,000 IRA contribution from ordinary income, a return of 10%, and a marginal tax bracket of 50%. The non-IRA increments assume that $1,000 of income tax is paid from salary each year, and that $1,000 remains to invest annually at 10%.

Retirement Aftertax value of

investment for

after year IRA Non-IRA

10 $17,500 $13,200

20 63,000 34,700

30 180,900 69,800

40 486,900 126,800

50 1,280,300 219,800

An IRA is obviously a powerful tax-saving vehicle -- if you get to age 59 1/2. But to take advantage of an IRA shelter, you don't have to wait that long. Soffer demonstrates that an IRA is an effective intermediate-term vehicle as well. The table indicates (interpolating to determine the 10% excise tax) that after 10 years, even a penalized withdrawal is ahead of the non-IRA investment. But that is not utilizing the IRA's sheltering potential most efficiently. Based on the same 50% tax and 10% interest rates, making one $2,000 contribution to an IRA and leaving it in for as few as five years pays off even better. And if the investment return happens to be higher, the period is shorter still: With a pretax interest rate of 15%, persons in marginal tax brackets from 30% to 50% would do better in about four years. Therefore, Soffer concludes, conservative-minded individuals who are reluctant to contribute to an IRA because they assume they will have to tie up funds until retirement should consider the efficacy of using an IRA for relatively short time periods.

The catch is that the arithmetic doesn't allow you to do this with maximum efficiency on an annual basis. If a contribution is made each year, it takes a while for the IRA investor to catch up with his non-IRA brother. In the earlier stages, an IRA's maximum annual allowable deduction of $2,000 immediately saves the $1,000 tax on ordinary income, and after five years the IRA holder will have accumulated -- through contributions plus compounded interest -- $13,431. Unfortunately, when the money is withdrawn, the investor must funnel half, or $6,715.50, into federal coffers. He also has to pay the 10% excise on the withdrawn sum, and that is the killer; this amounts to $1,343.10, netting him $5,372.40. Now let us see how the non-IRA 50%-bracket investor fares. First, of the $2,000 he might have contributed, $1,000 immediately goes into Uncle Sam's pocket each year. Therefore, he can invest only $1,000 at a time. And the interest earned is annually taxed at 50% as well. Even so, at the end of five years, his net cornpounded holdings amount to $5,801.92. So he is $429.52 better off.

But that is not how to engineer the shelter. Rather, the investor attempting to maximize his wealth must look ahead and, each year, determine how far down the line he will want to liquidate. Says Arthur Young, if it is 5 years hence, he can make only the first year's contribution for the IRA to come out ahead; if 7 years, he can put in 3 years' worth of IRA funds before he must stop; if 10 years hence, he should stop contributing after 5 years, and so on. As an example, contributing $2,000 for 3 years grosses $7,282. If this amount is withdrawn, the investor nets $2,912.80; the unsheltered investor nets $3,310. 13. But leaving the sheltered sum in the IRA for 5 more years, with no additional contributions, grosses the investor $11,727.73. Deduct 50% for income tax and 10% for excise tax, and the net is $4,691.10. Meanwhile, the unsheltered investor investing $1,000 for three years has netted only $4,224.66 compounded for eight years. Voila!

Using an IRA for intermediate-term shelter requires a new decision each year based on when you anticipate cashing out. Each time, the situation must be reviewed via such simple arithmetic. At some point, you will decide not to contribute any further and will simply let the interest accrue.

One might argue that a 50% taxpayer might be better off in tax-free municipals from the start. Occasionally, this may be true. But remember that the IRA shields all of the $2,000 available each year, whereas the taxpayer has only $1,000 left to invest annually. Therefore, the traditional gap between tax-free interest and taxable interest closes considerably.

Obviously, no personal financier is going to get rich with this tax-sheltering tactic, but it is fun to play winning hands with Uncle Sam, even on a small scale.