That's right, Fool, that comes straight from the editor of our Rule Your Retirement newsletter, who now says that IRAs are, um, less than desirable? That's just crazy talk, plain and simple.
How to beat Uncle Sam and retire wealthy
Here's the real scoop: IRAs come in two primary flavors, both of which offer tax advantages for the Foolish investor. Let's break them down.
First, there's the plain vanilla IRA. It's a tax-deferred account, which means you get to sock away pre-tax cash for retirement before the Feds get ahold of it. So, for example, if you contribute all $4,000 to your account in 2005, and your operative tax bracket is, say, 25%, you'll save roughly $1,000 on your tax bill. The drawback is that you'll have to pay taxes on your contributions, gains, etc. when you retire. And you'll have to do so at ordinary income tax rates.
Next, there's the sexier Roth IRA, to which you contribute after-tax dollars. In return, you get to keep whatever you accumulate, tax-free. It's a remarkably good deal. Too bad it isn't available to everyone. To take advantage of a Roth in 2006, you'll have to make less than $95,000 if you're single, or $150,000 if you're married and file jointly. Single filers who make up to $110,000 can make partial contributions, while couples lose out on the Roth once their income tops $160,000.
The fallacy of buy and hold
The argument against IRAs is that buy-and-hold investing shields gains better than an IRA can. Let's say, for example, that you buy Stock Advisor pick eBay (Nasdaq: EBAY ) and hold it for 30 years, all the way through to retirement. It never pays a dividend and you never sell a share. And, in that time, the stock becomes a 20-bagger, making your $10,000 investment worth more than $200,000. When you cash in, you'll only pay long-term capital gains taxes, leaving you with more than $170,000 in cold-hard moola. Nice.
Too bad it almost never works this way. I own plenty of stocks. And I've held several for more than one year, qualifying me for the long-term capital gains rate when I cash in gains. But there are always going to be times when you cash in a stock in a few months, either because it rose too fast, or the business model changed, or whatever. In those instances, the Feds will get their cut at your ordinary income tax rate. You've saved exactly nothing.
And what about mutual funds? Even if you don't trade in and out of them, you're likely to get stuck with a nice tax bill if the manager trades a lot. Plus, if he's successful, you'll have to pay capital gains taxes. A recent example: I've long owned shares of the very successful Julius Baer International Equity (FUND: BJBIX ) mutual fund. This winter I received more than $1,000 in capital gains. But I own the fund in my IRA, which means the Feds will be seeing none of those proceeds next week.
My point is simple: Eschewing IRAs because of the Foolishness of buy-and-hold investing is, well, foolish.
He was right the first time
Albert Einstein once called compound interest the most powerful force in the universe. His point was simple: The process of investing, and of reinvesting the proceeds, is the surest way to become wealthy. That's how it works with stocks. The lower you keep costs, the wealthier you'll become. Taxes just don't fit into that equation, and IRAs are one of the surest ways to insulate against them. Bro knows it; he's already said so. Now you know it, too.
Don't just retire. Rule! Editor Robert Brokamp may be on the wrong side of this debate, but his Foolish advice on investing, taxes, and life after 40 has proven invaluable to thousands of subscribers. Join the party by asking us for anall-access passto Rule Your Retirement. It's free for 30 days and there's no obligation to buy.
Fool contributorTim Beyershas two IRAs and is doing just fine, thanks. Tim owns shares of the Julius Baer International Equity fund. You can find out what else is in his portfolio by checking Tim's Foolprofile. The Motley Fool has an ironcladdisclosure policy.