One Great Move You Need to Make Soon

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:

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?