Get to Know Your IRA

If you think most Americans know the basics about investing and saving for retirement, check out the stats from this AARP Financial survey:

• Some 71% of surveyed Americans believe that IRAs are worthwhile, but only 39% of them have an IRA account.
• 44% of Americans, and half of those in the critical saving years between 18 and 49, profess ignorance about how IRAs work.
• More than half, 55%, don't know the difference between a Roth IRA and a Traditional IRA.
• More than a third, 36%, aren't sure whether they're eligible to contribute to an IRA, and two-thirds don't know that those 50 or older can contribute even more money each year.

The good news: These sad stats can be improved. If you're still in the dark about IRAs, read on.

How do IRAs work?
In a traditional IRA, the money you contribute gets deducted from your taxable income. For tax year 2008, the contribution limit is $5,000 for those who qualify, and $6,000 for those 50 and older. So if you earn $50,000 and contribute $5,000, your reported income will be $45,000, lowering your income bracket and saving you tax dollars up front. In exchange, when you start taking money out of your IRA (withdrawals become mandatory beginning at age 70 1/2), those funds will be taxable at your regular income rate.

With the Roth IRA, your contributions are made with post-tax dollars, making no dent in your taxable income for the year. But in return for that up-front tax hit, you get to enjoy those funds tax-free in retirement, with no mandatory withdrawals. So if your $50,000 in contributions grows to a nest egg of $350,000, you won't pay a dime in taxes on your $300,000 capital gain. Not too shabby!

If that kind of growth sounds impossible, think again: A 10% growth rate and 20 years will just about get you there. Where can you find that kind of performance? Check out these familiar stocks' 20-year average annual growth rates:

Learn much more about IRAs in our IRA Center. And for tips on retiring well, including stock and fund recommendations, take our Rule Your Retirement newsletter service for a free 30-day tryout.