When it comes to the alphabet soup of finance, remember these tips for your IRA and you may be able to avoid indigestion.
Put these tips on your smart money To Do list:
Think of the IRA as a way to take control of your finances amid an unpredictable market: You know that old saying about having the wisdom to know what you can and can’t control? Well, you can’t control the market’s ups and downs, but you certainly can make sure that your investments are as good as they can be, that your investment costs are low, and that you’re taking advantage of every tax-sheltered opportunity available, such as contributing to an IRA.
Bear in mind your overall asset-allocation plan: Size up your whole portfolio’s stock/bond/cash mix and take note of any big sector or style biases; also note any gaping holes in your portfolio. You can also compare your portfolio with a target-date fund designed for someone in your age range. If you find that you need to add to your holdings in a certain asset class or investment style, your IRA is a logical place to start.
Use an IRA calculator: These tools (make sure they are on a trusted and reputable Web site) can help you identify the IRA type that you’re eligible to contribute to and will allow you to maximize your return once taxes are factored into the equation. Moreover, they can provide valuable guidance in determining whether converting from a traditional IRA to a Roth makes sense.
Avoid These IRA Pitfalls
Don’t Forget About Your Spouse: Married couples that include a working and non-working spouse can maximize their after-tax results by setting up IRAs for both individuals. A so-called spousal IRA is an option as long as you file a joint return and the working spouse has earned enough qualifying income (be aware of limitations) to fund both his or her own IRA and that of the spouse.
Don’t assume that you need a lot of cash on hand to invest in an IRA: A strategy, called dollar-cost averaging, is a systematic way of investing equal dollar amounts at predetermined times. It allows an investor to purchase more shares of an asset when the price is low, and fewer shares when the price is high. It also makes an IRA a more-affordable option if you don’t have the full contribution amount on hand.
Don’t assume that you don’t need to contribute to an IRA if you already contribute to a 401(k): If you’re maxing out your 401(k), you should consider an IRA as well because IRAs can help you diversify the tax treatment of your retirement assets. For example, if you’re contributing the max to your 401(k), you’ll owe taxes on a considerable amount of assets when you retire and begin tapping the assets. Withdrawals on Roth IRA assets, meanwhile, will be tax-free. By hedging your bets among the two vehicles, you have less riding on a wager about whether tax rates will be higher or lower in the future; you also maximize your tax-deferred savings.
Don’t shelter investments with tax benefits inside an IRA: IRAs already offer tax-deferred (or in the case of a Roth, tax-free) compounding, so there’s no need to stash tax-advantaged instruments like municipal bonds within them. Save those for your taxable accounts and consider IRAs only after you’ve maxed out your tax-sheltered options.
Be sure to consult with a financial advisor or tax professional for the latest rules and regulations. Stocks are not guaranteed and have been more volatile than bonds. Municipal bonds may be subject to the alternative minimum tax and state/local taxes, and federal taxes apply to any capital gains distributions. Funds in a traditional IRA grow tax-deferred and are taxed at ordinary income tax rates when withdrawn. Contributions to a Roth IRA are not tax-deductible, but funds grow tax-free, and can be withdrawn tax free if assets are held for five years. A 10% federal tax penalty may apply for withdrawals prior to age 59 1/2. Please consult with a financial or tax professional for advice specific to your situation.
