If you've never thanked the heavens above for individual retirement accounts, there's a good chance you don't know enough about them. And you're not alone in that. Here are a few key things everyone should know about IRAs.
1. They're highly underrated
A 2014 survey from the folks at TIAA-CREF offered some alarming findings: 35% of respondents (and 45% among young adults) don't understand what an IRA is. Only 17% of respondents currently contribute to an IRA (down from 22% two years earlier). That's a shame, because IRAs are powerful, tax-advantaged tools to help you save for retirement. The two main kinds are the traditional IRA and the Roth IRA. The traditional IRA lets you deduct your contributions from your taxable income, lowering your tax bill that year. The money can then grow in the IRA account until withdrawn, when it's taxed at your income tax rate at the time. The Roth IRA rules don't allow you to deduct your contributions, but when you withdraw money from your account in retirement, it's all tax-free.
The tax advantage is a big deal. Your 401(k) plan at work is also tax-advantaged, but such plans typically offer you a limited range of investments for your money. You can open an IRA account at a good brokerage and then buy just about any stock or bond for it, along with gobs of mutual funds and ETFs. If you use a traditional IRA and are in the 25% tax bracket, a $5,000 contribution shaves $1,250 off your current tax bill and starts growing for you immediately. If you plunk $5,000 in post-tax money into a Roth IRA and it grows by 10% annually for 20 years, you'll end up with $33,600 -- which you can collect tax-free.
2. For best results, start early, max it out, and invest effectively
It's one thing to appreciate the IRA and to decide to contribute to one, but if you put it off and start by investing pocket change, you're doing your retirement a big disservice. For best results, contribute as soon and as much as possible. For 2014, the contribution limit is $5,500, plus an additional $1,000 if you're 50 or older. If you contribute $5,500 per year for 25 years and earn the stock market's long-term average return of about 10% per year, you'll end up with $595,000.
Procrastination comes easily to most of us, but it's costly when we're talking about retirement accounts. Think of the example above and imagine you started a year later, earning a 10% return on your $5,500 annual contributions for 24 years. That would give you a nest egg of $535,000. In other words, that one-year delay would have cost you $60,000!
That said, late is much better than never. Even if you only have 15 years for your money to grow, if you contribute $5,500 per year and average 8% annual returns, you'll still end up with more than $160,000, which can make a big difference when you retire.
3. You can change lives by spreading the word
This last bit of advice regarding IRAs isn't one you'll run across often, but it's important. Think of the 35% of survey respondents who don't understand what an IRA is and the 83% who aren't currently contributing to one. Many of them are your family members and friends. Spend a little time talking with your loved ones to make sure they're all doing what they can to save for tomorrow. Tell them all about IRAs, because the more people who are aware of this powerful retirement-planning tool, the better.
Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, has no position in any company mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.