[ The Money Side of Lifeā„¢ ]

Open An IRA: Your retirement savings starts now

By Jessica Dabrowski on May 1st, 2009 •

Planning for retirement is as necessary as food and water. Traditionally, individual retirement arrangements (IRAs) have been a go-to retirement standard. Yes, many IRA accounts suffered setbacks due to recent economic developments; but with an IRA you can invest in almost anything, so the level of risk is up to you. Starting now and utilizing an IRA as one part of a multi-faceted retirement strategy can help set up your future.

The basics

An IRA is a tax-favored investment account. Money in the account can be invested in many different vehicles ranging from money market accounts to stocks. The most common types of IRAs are Traditional and Roth.

Traditional: Pay taxes later

If you're in a high tax bracket now, consider a Traditional IRA, because contributions (invested money) are tax deductible. Income will likely be lower during retirement, so distributions (withdrawals) will be taxed at a lower rate. Here are some details:

  • Anyone under age 70.5 who earns income can contribute.
  • Distributions made before age 59.5 are subject to a 10% penalty.
  • Deductible contributions may be reduced if you're covered by a work retirement plan.
Roth: Pay taxes now

Most young people are in a low tax bracket, so a Roth IRA may be a better choice. With a Roth you pay income tax before contributing, and distributions aren't taxed. This means that you'll pay taxes when you're younger and in a lower tax bracket, rather than paying higher taxes later when you'll likely be in a higher tax bracket. Here are some details:

  • Anyone who earns income can contribute as long as adjusted gross income is less than $120,000 (single) or $176,000 (married filing jointly).
  • To withdraw distributions without penalties, a Roth IRA has to be open for at least five tax years and you must be at least 59.5 years of age.

Both Roth and Traditional IRAs have exceptions that allow for penalty-free withdrawals. These include some education expenses and first-time home-buying expenses. Search "all about IRAs" at fool.com and "Publication 590" at irs.gov for all the details and restrictions on both types of IRAs. If you're unsure which type of arrangement to choose, consult with a financial professional.

Opening options

IRAs can be opened through financial institutions, brokers or mutual fund companies. Keep in mind that the contribution limit for an IRA varies by year--the 2009 limit is $5,000 for people under the age of 50. IRAs can be actively or passively managed: either take charge and pick specific investments based on research, or have an account manager make those decisions. Start now, because every year that slips by is another missed opportunity to compound interest and make your money grow.

The Bottom Line

Assuming a 7% annual return, $1,000 invested annually from ages 20 through 30 (11 years/$11,000) will grow to $168,514 by age 65. Wait to start until age 30, even with $1,000 put in annually until age 65 (35 years/$35,000), and it will only grow to $147,913. That's $20,601 less, even with a principal investment that is three times as high.

Sources: taxpolicycenter.org; irs.gov; money.cnn.com; fool.com; investopedia.com; kiplinger.com; abcnews.com; bankrate.com; dol.gov