What's the No. 1 goal for investors? Retirement, according to most polls. Yet not every investor has an individual retirement arrangement (or account, depending on whom you ask) -- better known as an IRA.
This is a mistake. Every working American should have an IRA. Here are five reasons why.
1. How else will you retire?
If you don't contribute to an IRA, how do you plan on paying for your golden years? Social Security? Your company's traditional pension plan?
Hate to be the pooper at your party, but those sources probably won't completely replace your pre-retirement income. The Social Security system and defined-benefit plans weren't meant to. On top of that, they both have their funding problems, depending on your age and who you work for. So to enjoy the retirement you aspire to, you'll need personal savings.
You might be saving in an employer-sponsored plan (e.g., 401(k), 403(b), 457) instead of an IRA, and this might be the better choice if your boss matches your contributions to the plan. However, if that's not the case, you might be better off in a Roth IRA (if you're eligible), at least for a portion of your savings. Read Don't Max Out Your 401(k), Part II and Why the Roth Rules for the details, but generally a Roth is much more flexible and might provide more after-tax retirement income. "After-tax" is the key, which brings us to...
2. Lower taxes, lower taxes, and lower taxes
Take your pick: Would you like to take a tax deduction now and defer the taxes on your interest and capital gains, or to never pay taxes on your investments? It's up to you -- and your adjusted growth income (AGI), which determines whether you're eligible for a deductible traditional IRA (which means lower taxes now and until you retire) or a Roth IRA (which means no deduction, but you never pay taxes on the investments in the account).
To see how powerful this tax savings can be, consider the following example. According to Quicken's IRA analyzer, a 40-year-old who contributes $3,000 a year to an investment account and earns 8% annually on his investments would receive the following after-tax income upon retiring at age 67:
- Taxable account: $15,335
- Traditional IRA: $20,039
- Roth IRA: $24,438
An IRA would provide 30% to 60% more annual income than a regular investment account. That will pay for a lot of shuffleboard!
3. If you don't put money in an IRA, you'll spend it
Assuming you believe that saving money is good for you, then opening an IRA is very good for you. This is because contributing to an IRA moves money from the account with the gaping, leaky hole (otherwise known as your checking account) to an account with reinforced walls.
Uncle Sam discourages taking money from an IRA before retirement by imposing a 10% penalty on withdrawals before the owner turns 59 and a half. Also, earnings and deductible contributions will be taxed as income.
Logistically, it's not easy to get your grubby little hands on IRA money. You can't stop at the nearest ATM and get $200 from your Roth to pay for a night out on the town.
If you really need the money, it can be had -- but to the detriment of your nest egg. So consider an IRA an impediment to pre-retirement spending, which will do wonders for your post-retirement greens fees, cruise tickets, and grandchildren spoiling.
4. You want more control over your investments
If you're contributing to your retirement plan at work, your investment choices are probably limited. The majority of 401(k) investors cannot choose individual stocks or bonds, but rather must pick from a few ho-hum mutual funds. Then there are investors who have a huge chunk of their work-related retirement savings tied up in company stock.
If you don't like what your retirement plan has to offer, an IRA is the place for your money. If you open an IRA with a discount broker, you can buy stocks, bonds, real estate investment trusts, certificates of deposit, Treasuries, exchange-traded funds, index funds, and thousands of other mutual funds.
5. Favorable treatment for parents, debtors, and mortals
IRAs are treated differently than other accounts in many circumstances. For example, assets parents hold in a regular account can reduce the financial aid award their children receive for college. However, most financial aid formulas ignore retirement savings. Also, depending on the state, IRA assets are shielded from creditors. And IRAs also have estate-planning benefits, especially Roth IRAs.
Still not convinced you need an IRA? Then perhaps a visit to our IRA Center or Retirement area would help. Finally, if you'd like to talk to a financial pro about your particular situation, check out TMF Money Advisor.