NFRs2000NYC

My accountant keeps yelling at me to drop 4K a year into an IRA, saying its tax free INCLUDING interest, and that Im an idiot for not doing it. However, the interest is quite low, and the money is "locked" for 5 years. Is it a good idea, or will that money serve me better elsewhere....as a longterm investment/retirement that is....

DryCycle

An IRA is:
A "pile" of assets called an Individual Retirement Account. there are two types that I know of
Things I think I know about IRAs:

1. You can only put cash into it, but then you can use the cash to buy pretty much any type of investment vehicle you want, like shares of companies, mutual funds, ETF's, bonds, you name it.

2. $4000 per year is the limit for YOU, but you can also contribute an additional $4000 for your spouse, unless you are a certain age, and then the limit is $5000 for each potential account.

3. Traditional IRA contributions are entirely or partially tax deductible depending on income. Roth IRA contributions are NOT tax deductible. I do not know to what extent contributions to a spousal IRA are deductible. Contributions for IRA's set up for children are not deductible.

4. Rates of return are entirely dependant on the investment vehicles that you purchase with the funds in the account. I personally use an age-adjusted fund marketed by Vanguard (because it's easy), and some individual stocks, and have seen overall yearly returns ranging from +30% to -12% (that I can remember).

5. Your ability to remove YOUR CONTRIBUTIONS from an IRA differ according to which type of IRA you have. I (we) have two Roth IRA accounts, which I believe can be drawn down to a point (limited by my contributions) without penalty.

6. You can contribute to an IRA for a particular year from Jan 1 of that year to April 1 of the FOLLOWING year. There's probably some kind of catch, but I've never tried it, so I don't know).

7. While both Roth and traditional IRAs GROW tax-free, DISTRIBUTIONS differ according to the type of IRA that you have. Roth distributions after the age of eligibility are tax-free, but traditional IRA distributions are taxed according to your income bracket. Traditional IRA distributions must begin at age 70.5, but Roth IRA distributions do not have that limitation.

8. IRAs can be willed to someone after your death in the form of a trust, which avoids tax on the amount in the account, but distributions to the benneficiary are taxed (I don't know the rate).

Since you have retained the services of a financial planner, he or she can explain the advantages or disadvantages of Roth vs. traditional IRAs.

Keep in mind that your broker / advisor's interests may conflict sharply with your own. Be careful out there. I've seen people get really taken by sales pitches for expensive annuities and life-insurance products.

I set my IRA up at the local bank in about 20 minutes, I can adjust the account from home, it costs next to nothing to re-balance once per quarter, and the contributions come out of my money market account according to a set schedule that I don't have to think about. This isn't rocket science, so don't let your planner charge you like he's doing particle physics on your behalf.

NFRs2000NYC

Great read. Thanks for the info. So what would be an ideal IRA for me, a 26 year old single guy? Is Roth the way to go if Im looking to put away for retirement by.....whatever, say 50?

CoastS2k

I'm also a 26 yr old single guy...I think a Roth is a good way to go. I have one. You can get the money out without a penalty for a first-time home purchase (I did that) but otherwise you have to wait until you are 59.5 years old. But a Roth is a really sweet deal as you don't pay income tax on the money when you take it out.

Like DryCycle said, the IRA is really just a vehicle, you have options as to WHAT you put your IRA money in. Personally I have all of it in a no-load S&P 500 index fund...averages 8% a year.

DryCycle

The contributions that you make to a traditional IRA are tax-deductible. This is different from pre-tax in several ways that are bad:

1. Uncle Sam keeps the tax you paid on the income that you used to fund the IRA until you file taxes and get a refund.

2. Depending on how much money you make, the entire amount that you contribute may not be deductible.

3. The deduction for IRA contribution may push you over the edge into Alternative Minimum Tax territory.

Malloric

Traditional IRA is tax deferred (no income tax on the money you put in, but you pay normal income taxes on what you withdraw). Roth IRA you pay income tax up front but don't pay income taxes when you with draw the funds.

If you're talking leaving funds in for 30 years, Roth is usually the better way to go since the money you put in early will have grown significantly. It's better to pay taxes on 4000 now than 20,000 30 years from now. Most people do drop tax rates when they retire, so if you don't have a long time to let the money grow the Traditional IRA can be preferable.

The major disadvantage to Roth IRA over traditional IRA is the early withdrawal penalties are steeper. To be considered a qualified withdrawal you must be 59 1/2 and the funds you are withdrawing must have been in the account for at least 5 years. Non qualified withdrawals you pay a 10% early withdrawal penalty PLUS withdrawals are taxed at your normal income tax rate.

SD_S2K

Also depends on whether you need the tax write off now or not. I am a 1099 self employed insurance broker, and I need the write off. I have a SEP IRA, which is like a traditional, but for self employed persons. I can write off up to 40% of my yearly income or something like that. I put $15k into it this year to buy down my taxable income.

If you are self employed or 1099 contracted, look into it. As a 1099 you are not eligible for 401k so the SEP is the way to go.

I also use Vanguard, with half the money in the target date retirement fund a poster mentioned above, and the rest dispersed amongst various other Vanguard funds. Their funds are the best in the industry in terms of almost no fees.

cthree

You should absolutely be making your maximum $4K contribution to an IRA and it should probably be a Roth IRA unless you're over 40. Over 40 the tax benefits will probably shift the other way where you won't earn enough on the investment to make up for the upfront tax hit but your accountant can tell you what's the best depending on your situation.

If you can't save $4K/year for your retirement you are in serious trouble and need a reality check. We're talking about $75/week, $153 per paycheck if you get paid semi-monthly as most people do. You simply have your financial advisor setup an automatic contribution of $153 twice a month from your bank account to your IRA account and have it automatically invested and start earning investment returns immediately. No fuss, no muss and you'll never notice it's gone.

If you stay ultra conservative and earn a 5% return (basically all gov't bonds) on this program when you're 65 you will have saved, after tax:

From 25: $500K = $160K invested + $340K earned
From 30: $370K = $140K invested + $230K earned
From 35: $270K = $120K invested + $150K earned
From 40: $195K = $100K invested + $95K earned
From 45: $135K = $80K invested + $55K earned
From 50: $88K = $60K invested + $28K earned

Those numbers are 100% guaranteed. You can make even more but incur risk of loss as well as gain.

The best way to save money painlessly is to get involved and interested in your investments. I spend most of my play money on buying stocks. The entertainment value I get makes up for any risk. I'd much rather drop $1000 on a high flying tech stock than at a blackjack table. The buzz lasts longer and the deck isn't stacked against me. It's way more fun and the idea of saving money is built in since I'm spending to save.

NFRs2000NYC

No no, I can absolutely afford it, I was just wondering if that 4K a year would serve me better somewhere else, like a mutual fund, a CD, etc.

Basically, the only benefit of an IRA over a mutual fund lets say, is that they are not taxed correct?

Malloric

An IRA isn't an investment vehicle, it's merely a tax sheltered account from which to invest from.

Let's say you have $4,000 sitting in your savings account currently and the end of the year is approaching and you feel like investing it in a 12 month AA corporate paying 7%.

You can do that out of your savings account in which case your $4000 will be worth $4280. You'll then pay taxes on the $280 capital gain the next year.

You can contribute the $4000 to a Traditional IRA in which case you will get a tax refund on $4000 of your income (Say $1000 if you are at the 25% marginal tax bracket) and get the $4280 back and pay taxes on $280 in gains only when you take the money out.

You can contribute it to a Roth IRA in which case the account will grow to $4280 and you'll pay no taxes on capital gains.

You can invest the money in an IRA basically however you want. You can trade anything from bonds to futures. Long or short doesn't matter. You can even invest on margin, but the gains you make with leveraged money are not sheltered.