More Important Than Ever: Happy Birthday to the IRA

Though the deadline for funding the 2008 tax year retirement accounts passed on tax day, getting ready for next year’s contributions is a good idea! The sooner you invest in yourself, the greater the returns are going to be upon you retirement.

The rules regarding IRA accounts are fairly flexible, so it is important to keep up-to-date on what is going on. For example, the 2009 tax year saw some significant changes, and 2010 is likely to do the same. Contribution limits were raised to adjust for inflation (in $500 increments as deemed necessary) and mandatory withdrawals and distributions were suspended due to the economic collapse of the US stock markets, where the vast majority of IRA funds are invested.

Given the current economic climate, these retirement planning options are more important than ever before to US citizens, whose investment accounts have taken a huge beating in the recent past. More and more people have to delay their retirement because of the huge losses in the stock market, not an option anyone wants to be forced to take. A recent study showed that only 14% of households eligible to participate in contributing to their IRA did so; vast amounts of potential retirement savings are being foregone for a number of reasons.

Unfortunately the IRA is one of the most misunderstood investment options available to the public! It is estimated that roughly a third of adults don’t understand eligibility requirements for IRA and similar retirement savings accounts. An AARP survey showed that 40% of Americans don’t know that you can have both a 401(k) and an IRA account open. However, due to the large number of IRA variations and options available, virtually everyone with an income can contribute to at least one form of IRA. Many websites are available which detail exact requirements, but probably the best source of information is directly from the IRS website, available at www.IRS.gov.

Obviously, the biggest single advantage of IRAs is the decrease in tax exposure. Depending on which type you get, the money you contribute or the money you withdraw is taxed, unlike traditional investment and savings account in which both are taxed. In a traditional IRA, money is taken from your paycheck before it is taxed, but your withdrawals during retirement are subject to taxation. For Roth IRAs (so named after the chief legislative proponent of the account, Senator William Roth of Delaware) after-tax money is contributed. This means that your money has been taxed before being put in – nothing you withdraw can be taxed. Thus, you have the opportunity for tax-free retirement income!

The benefits between the two have some obvious differences. The Traditional IRA offers cheaper deposits and some up-front savings, but withdrawals are generally mandatory past a certain age and are taxed as income – if tax rates increase, you will lose a larger percentage of your total amount. Roth IRAs, on the other hand, are more expensive to contribute to, but offer the benefit of no taxation at the other end along with no required withdrawals, meaning you can leave you money in to grow until you need it. Roth accounts are also more flexible and have smaller penalties if you need to withdraw money early (before retirement age). Both accounts allow money to grow tax-free as long as nothing is withdrawn.

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