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Dueling Fools: IRA Bear

I know, it's pretty crazy for the local Fool retirement expert to be arguing against IRAs. So I'll throw Tim a bone and concede right up front that IRAs are perfectly swell ways to save for retirement. My wife and I have several IRAs, of both the traditional and Roth varieties.

But there are a lot of misperceptions about the IRA. (Quick, what's the "A" in IRA stand for? Nope, it's not "account" -- it's "arrangement." Just ask Uncle Sam.) Despite the wonderful benefits of an IRA, there are drawbacks. In many, if not most, cases, the pros outweigh the cons. But not always. So when should you say "no way" to an IRA? Let me count the ways....

1. Your employer-sponsored retirement account rocks. Does your employer match contributions to your 401(k)/403(b)/457/SEP/SIMPLE/hike/hike/hike? If so, then don't even think about contributing to an IRA until you have taken full advantage of that benefit. The most common formula is an employer matching 50 cents for every dollar contributed, up to 6% of the employee's salary. That's an instant, guaranteed return of 50% on your contribution. Try getting that in your IRA!

Even if your contributions aren't matched (either because your employer is stingy or you've maxed out the benefit), spurning an IRA for your work plan might still be worth considering. The money is taken straight out of your paycheck (so you don't have to remember to write a check, and you can't spend it before you remember), and you only have to deal with one account -- which is a great benefit if you're into asset allocation and regular rebalancing, as most of us should be. (Rebalancing across many accounts can be a real pain!)

Now, my general advice is to contribute enough to your work plan to get the full match, then consider a Roth IRA. But if you're not eligible for the Roth and your work plan is a good one (i.e., it features a wide range of choices, low costs, and perhaps the ability to buy individual stocks), you may not need an IRA.

2. Contributing to a traditional IRA might result in higher taxes in retirement. I'll start this one with another concession: The Roth IRA is awesome. If you're eligible, then there are few reasons not to max it out.

But what if you're not eligible -- should you contribute to a traditional IRA? After all, contributions might be tax-deductible (if you're eligible) and investments grow tax-deferred. But then there's that little matter of retirement withdrawals. Here's where Uncle Sam says, "It's payback time."

Withdrawals from traditional IRAs are taxed as ordinary income, at rates of 10% to 35%, depending on your tax bracket. Compare that to long-term capital gains (i.e., profits made on investments held for more than a year), which are taxed at rates of 5% for those in the 15% income bracket and below, and at 15% for those in the 25% income bracket and higher. So if you, as a retiree, sell a stock you've held for a long time in your IRA, and then withdraw the money, you've converted a long-term capital gain into ordinary income. In other words, you've just turned a profit that would be taxed at no higher than 15% into something that could be taxed as high as 35%.

So if you are a long-term buy-and-hold investor, should you consider buying the stock in your taxable account instead of in your traditional IRA? No ... if your contribution to a traditional IRA is tax-deductible and you think you'll be in the same tax bracket or lower in retirement. However, if that is not the case, or if you expect tax rates to be higher in the future -- while capital gains will still be taxed at a lower rate than ordinary income -- then your money might be better invested a stock or tax-efficient stock fund (such as an index fund), rather than a traditional IRA.

3. You gotta take it sometime. There's another problem with traditional IRAs: Uncle Sam doesn't let the party go on forever. By the time you're age 70 1/2, you have to start taking money out -- whether you need it or not. For investors who have accumulated quite a bit in their accounts, these so-called "required minimum distributions" can be large enough to push investors up a couple tax brackets. (Actually, you can wait until the year after you turn 70 1/2, but then you have to take two years' worth of distributions. And that could result in one nasty tax bill.)

4. And the rest ... Finally, there are a few other drawbacks to IRAs. You generally can't use capital losses to offset gains and income, you can't deduct taxes withheld on foreign investments, and you might pay penalties if you need to withdraw money (for retirement or otherwise) before you're age 59 1/2.

So yes, Tim, IRAs rule. But for every rule, there are exceptions. And there are times when contributing to an IRA may not be the best arrangement.

Think you're done with the Duel? You're not! Go back and read the other three arguments, and then vote for a winner.

As the editor of the Fool'sRule Your Retirementplanning service, Robert Brokamp knows that his 401(k), several IRAs, and a swatch of carpet from Elvis' Jungle Room will put the glitter on his golden years.


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