So Tim found my cyber-paper trail and outed me: I'm a big fan of IRAs. I can't hide it. Me saying that IRAs stink would be like Paris Hilton claiming she's a virgin. You just can't refute the evidence. I'll help Tim's bull argument out even more by saying loud and clear that each and every working American should have an IRA or two.
But I'll also say that investors should think twice about putting each and every investment dollar in an IRA. It all has to do with "asset location" -- an important but seldom-discussed topic (though I cover it quite a bit in my Rule Your Retirement service). You see, some investments have built-in tax advantages. Put those investments in a traditional IRA -- or a 401(k), 403(b), or 457 -- and you essentially negate those built-in tax advantages. Here are a couple of examples:
- Interest from Treasury securities is free of state income tax, and interest from municipal bonds is free from federal income tax (and usually state income tax for residents). However, if you put those investments in a traditional IRA, the withdrawals are taxed as ordinary income on both the federal and state levels.
- Like long-term capital gains, qualified stock dividends are taxed at rates of 5% or 15%, depending on the investor's tax bracket. Let's say you're in or near retirement, and you buy a high-yield stock in order to provide income. Put that stock in a traditional IRA, however, and you turn that tax-favored dividend income into ordinary income -- and you'll pay higher taxes.
Generally, if you're years -- and especially decades -- from retirement, an IRA is the way to go. But as you near retirement, you need to seriously consider your "asset location," and begin to build a pile of investments outside your retirement accounts. It'll allow you more flexibility in managing your tax bill, more flexibility regarding when (and if) you have to sell investments, and it might even protect more of your Social Security from taxation.
So Tim will win this Duel -- with more than a little help from me; heck, I essentially fell on my sword. But heed my dying words: Stuffing your traditional IRA right up until the day you retire may not be the best idea.
Robert Brokamp is the editor of the Rule Your Retirement planning service, featuring loads of advice about asset allocation, asset location, and asset last-ation. Don't believe us? Give it a 30-day free trial and see for yourself.