With 2013 come and gone, millions of people will resolve to make the most of their money in the coming year. Yet with the stock market moving sharply lower to begin the new year, many investors might well miss out on taking a vital step toward ensuring their long-term financial security by opening an IRA for 2014 as soon as possible.
One of the most important things you can do to start 2014 off on the right foot is to start thinking about saving for retirement. That's a tall order for many people, especially those with decades to go before they can even start dreaming of retiring. But if you want to retire rich, you have to look ahead, and having an IRA is a vital tool you can use to bring that goal closer to reality.
Why it's important to act now
Those who've followed this column know that I traditionally beat on the IRA soapbox at the beginning of most years. Last year, uncertainty about recently enacted tax rates gave some investors good reasons to wait on funding their IRA. But now that the tax-law picture has firmed up, IRAs look more attractive than ever in many ways.
In particular, the fiscal-cliff compromise that took effect at the beginning of 2013 raised tax rates on high-income taxpayers, reestablishing the 39.6% tax bracket and adding new taxes of 3.8% on investment income and 0.9% on wage income above certain high-income thresholds. Even preferential rates on capital gains rose from 15% to 20% for top-bracket taxpayers. As a result, the tax deferral benefits from IRAs are more valuable than ever for many.
Now it's true that you have plenty of time to make an IRA contribution for 2014. Indeed, you can still make a contribution to an IRA for 2013 until April 15. But the bull market of the past five years has emphasized just how important it is to put time on your side by getting money into an IRA sooner rather than later. At the same time, IRAs also make it easier for you to manage your risk than taxable accounts.
The value of high-growth stocks in IRAs
Investing in high-growth stocks within an IRA highlights the full potential that tax-deferred retirement accounts provide. For instance, Max Levchin, a well-known entrepreneur in the technology industry who was the co-founder of eBay's PayPal division, demonstrated the value of a Roth IRA a couple years ago when the social-network company Yelp came public. SEC filings showed that Levchin's Roth IRA owned more than 13.25 million shares of Yelp, and based on valuations at the time, the Roth IRA likely earned a gain of about $100 million when Yelp went public. Since then, Yelp has tripled in price, meaning potentially greater gains for any shares that Levchin has kept in his Roth.
Yet the other side of the coin gives another advantage of IRAs: You can sell your shares of high-flying growth stocks at any time without tax consequences. That can help IRA investors avoid traps that others traditionally fall into after long bull markets.
For instance, during the 1990s tech boom, millions of investors rode tech stocks to riches. Yet for those who held those stocks in taxable accounts, the prospect of losing a huge chunk of their capital gains to taxes led many to avoid selling shares. As a result, many investors ended up riding tech stocks all the way back down, never reaping any profit from the boom at all. By contrast, investors in an IRA were free to sell whenever they decided the tech boom was over, with no immediate tax consequences.
Some investors see similar signs of overpricing in today's market. In particular, tech and social-media stocks have become a target of those arguing that a new bubble has formed. In particular, Twitter (NYSE:TWTR) has enjoyed phenomenal gains in the couple of months since it went public, more than doubling from its IPO price and climbing substantially higher from where it traded on its first day as a public company. Similarly, Facebook (NASDAQ:FB) and LinkedIn (NYSE:LNKD) have produced stellar growth in boosting advertising revenue, especially with Facebook having demonstrated its success in the mobile ad space. Yet with these stocks carrying pricey valuations that reflect investors' high expectations for their future, anything short of perfection going forward could cause dramatic corrections -- corrections that those investing in taxable accounts will fear protecting themselves from because of the tax liability involved.
Obviously, if you don't yet have an IRA with winning stocks in it, then you can't take full advantage of every opportunity that IRAs give you. But the sooner you establish an IRA, the sooner you'll be able to consider all of these winning strategies while leaving yourself able to take action if downturns change your investing mindset.
Tune in for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.