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What would you do if I told you that there was a way to legally avoid federal income taxes?

I'd say that the Fool has really lost its marbles this time. What is this, one of those crazy tax-protester theories where if you read the Declaration of Independence backwards it turns out that Congress has no power to levy taxes or something?

No, it's really legal. In fact, it's encouraged. I'm talking about --

Uh-huh. Uncle Sam doesn't generally "encourage" people to forget about taxes, buddy boy. What is this?

As I was saying, I'm talking about IRAs. This is the time of year when a lot of people are thinking about making contributions to IRAs, and it's the time of year when a lot more people should be thinking about setting one up or contributing to the one they have.

Oh geez, IRAs. You know if you look up "boring" in the dictionary, there's a picture of an IRA next to the definition?

You think so? That Autodesk (Nasdaq: ADSK  ) stock you bought last year -- what did you pay for it?

About $12 a share. Two thousand shares.

And it's around $24 now. That's $24,000 of profit in less than a year. Nice. So how much of that will go to taxes?

Well, I haven't sold it.

But if you did sell it, that $24,000 would be taxed as income, even if you turned around and bought something else with it. Right?

Well, yeah. But --

But if you had made that trade in an IRA, there would be no taxes on the profit when you sell. You wouldn't be able to spend the money right away, but this is all long-term savings for you anyway, right?

Yeah, yeah, I know. Look, this isn't news. Why are you writing an article about this?

Because a lot of people "know" about the advantages of an IRA but never take any action to get one, or they take action once and then never do anything with it again because they think their 401(k) is enough.

Look, contributing to your 401(k) at work is important. It comes right out of your paycheck before taxes, it's painless, lots of employers kick in some matching funds, you can invest it in something that will get you some growth over time, and if you max it out every year and you aren't stupid about choosing investment options, you'll have a decent retirement.

But you can do so much more with an IRA. In a 401(k), you're usually limited to just a handful of investment options, usually mutual funds chosen by somebody in the company's benefits department. In an IRA you can buy almost anything -- stocks, bonds, exchange-traded funds, even some kinds of options.

So? An index fund isn't all that bad, is it?

No, but consider this. If you put $10,000 in a Standard & Poor's index fund 10 years ago, you've actually lost money. Even under more normal circumstances, if you earned an average 10% annual return, you'd have around $22,600 after 10 years.

But if you'd taken that $10,000 and bought five good, solid stocks in your IRA, even right at the top of the Internet bubble, you'd have a little more:

Stock

CAPS Rating

Initial Investment

Current Value

Altria (NYSE: MO  )

****

$2,000

$14,007

Adobe Systems (Nasdaq: ADBE  )

****

$2,000

$4,262

Southern Company (NYSE: SO  )

****

$2,000

$6,948

Nike (NYSE: NKE  )

***

$2,000

$6,164

General Dynamics (NYSE: GD  )

****

$2,000

$6,910

Data from Motley Fool CAPS and Yahoo! Finance. Assumes an initial investment of $2,000 per stock made on Jan. 26, 2000, through market close on Jan. 26, 2010, including reinvestment of dividends and adjustment for spinoffs.

You'd have $38,291, to be exact. And note that none of those are shoot-out-the-lights stocks or great-in-retrospect 60-plus-baggers like Hansen Natural (Nasdaq: HANS  ) . They're just solid companies you might have bought 10 years ago -- or might buy now.

And there are no taxes on the gains. Either you don't pay taxes until you cash out and make withdrawals, with a traditional IRA -- or you never pay taxes on the gains at all, with a Roth IRA.

Again, this is all simple and important and everybody knows it -- but so many people don't do it. If you're eligible, you can contribute up to $5,000 for 2009 ($6,000 if you're 50 or older) -- and yes, you can do it now and still count it toward 2009 on your tax return. If you need to learn more, just hit our handy-dandy IRA collection for the full scoop. Why not sit down and take care of it right now?

Read Rule Your Retirement and learn all the tricks of wringing the most out of your retirement savings dollars. Try it free for 30 days, with no obligation to buy.

Fool contributor John Rosevear owns shares of Autodesk. General Dynamics is a Motley Fool Inside Value recommendation, Hansen Natural is a Rule Breakers selection, and Adobe Systems is a Stock Advisor pick. Southern Company is an Income Investor choice. The Fool owns shares of Autodesk. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (1) | Recommend This Article (6)

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  • Report this Comment On March 31, 2010, at 2:38 AM, 2humble2fool wrote:

    So. . . if we were all smart enough to pick a 7 bagger, 3 three baggers and a 2 bagger with five picks 10 years ago we would all be as rich as Buffet now wouldn't we. Don't you think that's just a little unrealistic as far as expectations go? Me I must be a mere mortal because I always end up picking some stocks that do quite well (even though I have yet to have anything close to a 60 plus bagger), a few that kinda hold their own and a few that don't do nearly as well as I had hoped. Funny I think that is the way it is for most all of us.

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John Rosevear
TMFMarlowe

John Rosevear is the senior auto specialist for Fool.com. John has been writing for the Fool since 2007. A lifelong car nerd, his current daily driver is a Cadillac CTS-V.

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Related Tickers

4/17/2014 3:59 PM
ADBE $64.04 Up +1.00 +0.00%
Adobe Systems CAPS Rating: **
ADSK $48.49 Up +0.94 +0.00%
Autodesk, Inc. CAPS Rating: ****
GD $109.06 Up +0.88 +0.00%
General Dynamics CAPS Rating: ****
MNST $67.55 Up +2.13 +0.00%
Monster Beverage CAPS Rating: ***
MO $38.45 Up +0.09 +0.00%
Altria Group, Inc. CAPS Rating: ****
NKE $74.03 Up +0.93 +0.00%
Nike CAPS Rating: ****
SO $45.12 Down -0.70 +0.00%
Southern Company CAPS Rating: ****

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