From Ken Little,
Your Guide to Stocks.
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IRAs are a great way to save for retirement and take advantage of tax-deferred or tax-free grow of your investments.

If you don’t have an IRA account with your broker, they will be glad to set one up for you. In it your can trade stocks just like your regular account as long as you stay within the annual contribution guidelines – more about those below.

Why bother with an IRA? Two reasons: they are great retirement saving tools and you can use them to gain some tax advantages to your investing.

There are two main types of retirement IRAs:

• Traditional IRAs
• Roth IRAs

While there are other types, these two are the most frequently used in retirement planning.

Contribution Limits

Both IRAs have some contribution limits, which you need to observe. For tax year 2004, the limit is $3,000. That limit increases to $4,000 in tax year 2005. It jumps to $5,000 in 2006.

In addition, taxpayers age 50 and older can put in an extra $500 per year as a “catch up” through 2005. After that, it jumps to a $1,000 per year over and above the regular contribution limits.

Tax Advantages of Traditional IRAs

The main tax advantage of the traditional IRA is the money comes off your gross income for tax purposes. This means you get to deduct the amount of your contribution from your gross income before your figure your taxes. This lowers your current tax bill.

For example, if your income in 2004 was $60,000 and you funded an IRA for $3,000, you would only figure your income tax on $57,000.

If you or your spouse participates in an employer-sponsored retirement plan like a 401(k), some or all of your IRA may not be deductible. Whether your IRA is deductible depends on your income. Here is an online calculator to help you determine if your IRA is deductible.

In addition to reducing your current income, all growth of your IRA is tax deferred until you begin withdrawals if you follow the rules. Except in certain circumstances, you can’t begin withdrawal before age 59½. If you do, you will pay a 10% penalty. When you begin withdrawals, you will pay income tax at your current rate.

You can buy and sell within the IRA and avoid capital gains taxes (but not commissions), although active trading may not be a good strategy.

Tax Advantages of Roth IRA

The Roth IRA offers a tax advantage of a different type. Your contributions give you no current break on your income tax like the traditional IRA.

However, when you start taking money out of a Roth IRA it is tax-free. Your contributions have already been taxed, since you fund the Roth with after-tax dollars. Your earnings in the Roth IRA grow tax-free, which is different from the traditional IRA.

If you anticipate that you will be in a high income tax bracket after you retire, the Roth IRA may be one way to provide some tax-free income.

The contribution limits for the Roth are the same as for the Traditional IRA.

You can contribute to a Roth IRA if your modified adjusted gross income is below $110,000 for people who file as singles. If you file jointly, the income level is $160,000. Check with your broker for more details.

When to Open

You can open an IRA anytime before you file your taxes for the previous calendar year (usually April 15). However, it is in your best interest to fund your IRA as early as possible.

The more time it has to grow in either a tax-deferred or a tax-free environment, the more it will be worth when it comes time to make withdrawals.

Conclusion

IRAs are great tools for adding some tax-advantaged investments to your portfolio while building a retirement account. Your broker can get you started if you don’t already have an account. If you do have an account, fund your IRA as early in the year as possible to take maximum advantage of tax-deferred or tax-free growth.