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The First Thing You Should Do in 2013

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With New Year's finally behind us, it's time to look forward and take steps to improve your investing and your financial life. Yet unparalleled uncertainty still exists, making 2013 an unusual year and thereby changing what has often prevailed as conventional wisdom.

That's why this year, you'll see different advice in this column than you've gotten in recent years. In 2009, 2010, 2011, and 2012, opening and funding an IRA to save for your retirement earned top-priority status. But with so much about tax planning issues up in the air right now, you need a more flexible strategy that can adapt to the ever-changing legislative environment.

Why IRAs are still smart
To be clear, I'm not saying that IRAs are a bad way to invest even under whatever tax laws end up prevailing in 2013. Unless unexpected fundamental changes in the way retirement accounts get taxed somehow become law, IRA investors will still get the benefit of tax deferral for as long as they keep their assets in their retirement accounts, and those who choose Roth IRAs will benefit from tax-free withdrawals in retirement.

In fact, with tax rates on dividends and capital gains on the rise at least for upper-income taxpayers, the value of keeping assets in an IRA will increase in 2013. Taxpayers won't have to face a near-tripling of taxes on dividends this year, but with the compromise position raising the maximum rate from 15% to 20% on upper-income taxpayers, IRA owners in those brackets will appreciate the lack of taxation on their retirement-account dividends even more.

Why waiting makes sense this year
I'm a big fan of getting money into retirement accounts as early as possible. But this year, the unprecedented level of uncertainty about taxes makes it extremely difficult to do a precise analysis of what type of IRA you should use. Even with a fiscal cliff deal done, you can't be absolutely certain that even basic issues like current-year tax rates are truly off the table, let alone more complex considerations like the various deductions and credits available to taxpayers.

Elsewhere in the retirement realm, one thing remains true: If your employer offers a 401(k) plan that includes a matching contribution, don't wait; get in touch with your HR representative and start putting enough money into your 401(k) account to get the full match. Turning down free money doesn't make sense with most 401(k)s, and with the majority of employers offering only traditional 401(k)s rather than Roth 401(k)s, your limited options make the decision an easy one.

Why you should still do an IRA this year
So if 401(k) plans are a surer bet this year, why bother with IRAs at all? After all, 401(k)s let you save a huge amount toward retirement -- $17,500 for those under age 50 this year, and $23,000 for those 50 or older -- and make the lower limits of $5,500 and $6,500 respectively for IRAs look puny by comparison.

But the major difference with IRAs is that you can pick and choose just about any investment you want. Consider some options:

  • Few 401(k) plans give their participants a chance to invest in individual stocks. So if you like picking top stocks rather than tracking indexes, you might not get the opportunity in a 401(k) account. With an IRA, though, the choice is yours.
  • With most 401(k) plans, if you want to invest in gold or other precious metals, you're out of luck. But with access to ETFs SPDR Gold (NYSEMKT: GLD  ) and iShares Silver (NYSEMKT: SLV  ) as well as a host of specific mining companies, an IRA brokerage account will let you pick and choose your exact exposure. You can even find specialty IRA providers that let you own certain types of bullion coins in an IRA if you want.
  • Even if you like funds, your 401(k) plan might not give you access to the best low-cost funds. Paying big sales loads for captive retirement assets is unconscionable, but some 401(k) plans nevertheless stick you with those undesirable investment options even for basic asset-allocation strategies. With an IRA, you're never trapped, as you can always fall back on low-cost ETFs Vanguard Total Stock ETF (NYSEMKT: VTI  ) and iShares Core Total US Bond (NYSEMKT: AGG  ) as ways to put together a simple split between bonds and stocks.

So start setting your IRA money aside, but consider waiting until you have maximum clarity about taxes before you make a final decision about what type of IRA to use. That way, you'll avoid the complications of trying to recharacterize a contribution after the fact and keep things as simple as possible while still getting the full tax benefits that IRAs offer.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.

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Read/Post Comments (17) | Recommend This Article (116)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 03, 2013, at 4:04 PM, fool3090 wrote:

    I'm not so sure about this one, Dan. I think Roths are the best idea ever.

    I wouldn't hesitate to figure out whether to go Traditional or Roth. If you have a 401(k), that will cover the tax-deferred side but with a fully funded Roth working side-by-side, you have the best of both worlds.

    I do 10-plus percent in my 401(k) to get tax benefits and the max out the annual Roth at $6,000/year. It's a save-til-it-hurts rate, but it's the only chance I have to retire comfortably.

    When the time comes, I will have a choice of fund categories to draw from: the tax-free or tax-deferred. SocSec is a wild card and who the hell knows what will happen there. So it's best to have a flexible plan.

    The drawback to your suggestiong is basing long-term strategy on short-term tax policy controlled by Congressional meatheads.

    Do both -- Roth and 401(k) -- and save hard! Then you have a One-Two Punch at 62, 65 or whenever you hang it up.

    My two cents (which will be worth 7.3 cents by my projected retirement date, assuming above-market returns and reinvested dividends!)

  • Report this Comment On January 04, 2013, at 7:40 AM, TMFGalagan wrote:

    @fool3090 - Yours is a completely reasonable strategy for someone who has enough money to save both in an IRA and a 401(k). And to be clear, I'm not suggesting anyone put off the IRA decision forever - rather just for a month or two until more of the details of the fiscal negotiations become clearer.

    best,

    dan (TMF Galagan)

  • Report this Comment On January 04, 2013, at 12:00 PM, gwc11 wrote:

    This strategy sounds great for someone who is working. How about something for someone who is retired and just looking to beat banks and credit union interest on savings!

  • Report this Comment On January 04, 2013, at 12:46 PM, TOM48 wrote:

    @fool3090..You are absolutely on the right track. I am retired from GM. Last year GM sold our pensions to Prudential. I elected to take the lump sum. I had Roth IRAs for both my wife & myself. I rearranged my holdings by putting monthly dividend payers in our Roths. I was able to produce more income per month than I would have gotten from the pension tax free + I still had over $100000 to invest in my other accounts. If I had not opened the Roth's when I did, this option would not have been available to me. Roth IRAs saved my future.

  • Report this Comment On January 04, 2013, at 1:28 PM, whdaly5 wrote:

    Can a retired person with some outside consulting income and over the age of 73 invest any of this income in a Roth IRA?

  • Report this Comment On January 04, 2013, at 2:08 PM, WineHouse wrote:

    @fool3090 -- YOU ARE 100% CORRECT about Roths. They are MUCH better than traditional IRAs in the long run. Anyone who thinks that a tax deduction today is worth more than totally tax free accrual accumulations that will never ever be taxed PLUS no RMDs that literally require you to be taxed PLUS taxation at full freight (whatever your top bracket situation is) rather than the cap-gains and dividend rates is truly a fool. Now that the income cap on Roths is essentially gone (just put the IRA contribution into the traditional IRA and pay the tax anyway since you're obviously above the cap for tax deductibility, then convert that amount into a Roth the very next year and pay whatever tiny tax might be due on the year's worth of accumulated accruals) and your'e done -- do it every year and you'll be set for life. Doing anything else is downright foolish.

  • Report this Comment On January 04, 2013, at 3:36 PM, TimetogoMF wrote:

    @winehouse-- Your comment makes some sense but mostly for folks that are at or near the top 2% and expect to have as much income in their retirement years as they do during working years. I'm in my early 50's and I'm putting 20% in my 401-k and maxing out a Roth IRA where I can do my own stockpicking while putting a kid through college with another right behind him. I do this living fairly frugally and avoiding any debt now that things are all paid off. But with no mortgage and no college to pay for once that's done I don't won't need the income the wife and I have now so my tax bracket should be much lower by the time I have to take RMD's from my 401-k and rolled over IRA. The tax savings I'm realizing while working while being in a higher tax bracket now is just as nice as the non-taxed Roth earnings I'll be living off of when I retire within the next 5 years until I have to start taking withdrawals from my tax deferred accounts and whatever Social Security I get. By saving so much now and paying off all debts by the time I retire I can still most likely live off half of what we make combined now.

  • Report this Comment On January 04, 2013, at 4:19 PM, TimetogoMF wrote:

    @whdaly5 -- Being retired should have nothing to do with your ability to put funds into a Roth IRA. See link for more info.. http://www.rothira.com/roth-ira-limits

  • Report this Comment On January 04, 2013, at 4:41 PM, TMFGalagan wrote:

    @whdaly5 - As long as you have earned income - which includes outside consulting income as long as you're earning a profit from the business - and aren't above the income limits for contributing to a Roth IRA, then you should be able to proceed.

    good luck,

    dan (TMF Galagan)

  • Report this Comment On January 04, 2013, at 9:20 PM, PonderingItAll wrote:

    One great things about having most of your investments in a ROTH IRA, is what happens once you start collecting Social Security: Qualified distributions from your ROTH IRA are not counted in your MAGI, but most other income is (including tax-free interest and bond dividends). If your MAGI exceeds certain limits, your Social Security income becomes taxable, and more taxable the more you are over the limit.

    By designing your retirement for mostly ROTH distribution income, your Social Security benefits may be completely tax-free. And with any luck, you may be collecting those benefits for a LONG time.

  • Report this Comment On January 06, 2013, at 1:58 PM, Sandycwb wrote:

    I would like to see advice split between tax advice which applies only to US, and your usual excellent market advice which can apply to all investors. Speaking of which, it would be nice to see more international advice, even if it is only relative economic security and sector strength.

  • Report this Comment On January 06, 2013, at 4:03 PM, TMFGalagan wrote:

    @Sandycwb - Thanks for your comments. I try to do a fair spread across domestic and international stocks and touch on tax and other personal finance topics regularly. But I'll take your comment to heart.

    best,

    dan (TMF Galagan)

  • Report this Comment On January 07, 2013, at 1:03 PM, PoorerThanU wrote:

    You folks proclaiming that Roth's are the only way to go are not being mindful of different people's situations. If you are young (even 50 years young), the Roth is the hands down favorite if you have 7+ years to retirement/drawing the money.

    If you are older (or near the end of earning income), the traditional makes better sense if you use it correctly. Let's say I am 63 and plan on retiring at 65 with very little income outside of my job income. If contribute $6,500 to my Traditional IRA, I get a $6,500 reduction in my income. Upon retiring at 65 I withdraw the contributions along with (hopefully) the earnings. My taxable income (AGI) might actually be zero depending on my other income sources. So I just reduced my earnings for this year by $6,500. Quite a savings!

    Everyone tends to give advice based upon their own personal situation and not the other persons situation. You older folks...please be aware of this when reading these comments. Seek out tax counsel from someone you trust. NOT A BROKER! That guy/gal is just a salesman. Yeah, yeah, I know *some* of them do more and better, but most do not. And, if you had a relationship like that with a broker, you wouldn't be on this website looking for advice now would you?

  • Report this Comment On January 07, 2013, at 3:38 PM, renosnave wrote:

    I once had a financial advisor tell me that there's no way the Gov can promise that Roth distributions will be tax free forever. Social Security was once not supposed to be taxed... and then they had to change that. Is it possible that all the gains of Roth IRA's might one day fall under taxation?

    I'm genuinely not sure... what are thoughts?

  • Report this Comment On January 07, 2013, at 7:46 PM, drdruz wrote:

    I would consult a tax expert before adding GLD to an IRA. The prospectus clearly states it has been ruled a collectible and as such will be taxed at a capital gains rate of 28% if held greater than 1 year.

  • Report this Comment On January 10, 2013, at 7:02 PM, chris293 wrote:

    One, I do not want the government to be controlling my money, especially when they can not contol they own money except to go into debt.

    It just a feeling that even mutal funds are not the best investment for people who are sober enough to manage their own portfolios. Of course, a Motley Fool business guide for investors, some business courses at the local college, or a DIY business book could save people a lot of money and time.

  • Report this Comment On January 10, 2013, at 8:04 PM, magnum440 wrote:

    Referring to the comment on the possibility of a Roth being taxed later: I was told the same thing by an adviser at a seminar. Basically there are no guarantees. Just look at what is happening in government now. Remember taxes go 'up' and tend not to go down.

    No one knows what will happen...

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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