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What in the world is an IRA?
Jude Stewart

An Individual Retirement Account is an arrangement allowing individuals to save money for retirement in a tax-advantaged manner. For you cats frittering away your last winks of sanity worrying about retirement, we're limiting this discussion to the two most popular types of IRAs, Roth and traditional. And let's get one common misconception out of the way right here: An IRA is an account, not an investment. You can put just about whatever you want into your IRA -- stocks, CDs, mutual funds, cash, bonds -- just about anything, except options, and other derivatives.

Vhat I can do with thees, how you say, IRA? Since rhetoric on IRAs has grown increasingly mind-numbing as new wrinkles and exceptions to the tax rules proliferate, let's take this discussion old school and do the basics. The retirement formula for most employees these days does not revolve around the promise of Social Security and defined-benefit, corporate-sponsored pension plans. Nowadays the watchwords for funding retirement are "defined contribution" retirement plans ("Defined BENEFIT" means a company's plan guarantees eligible employees a specific payout, whereas "defined CONTRIBUTION" plans specify how much employees can contribute themselves to a plan but don't guarantee a minimum payout). In other words, funding individual retirement has largely become the worry of individuals themselves, not the government or the Man.

Anyone with earned income -- working for someone else, self-employed or alimony -- can invest up to $2,000 a year in a standard IRA ($4,000 for married couples). For tax year 2000, an individual earning less than $32,000 can invest that entire $2,000 in pretax dollars ($52,000 for couples filing jointly). Even if you earn more than that, you can still deduct some of your contribution, since $32K is where the "phase-out" begins.

That's a big break because it lowers your Adjusted Gross Income (AGI), which means you pay tax on a lower income. In other words, if you made $35k in 1999 and maxed out on your traditional IRA contribution at $2,000, you'd only be taxed on $33,000 in income. If you (and your spouse) don't have access to a workplace retirement plan, then you can deduct the amount you contribute, even if you earn over the $32K limit.

Down side: this account is really meant for retirement, so if you try to sneak out any funds prior to your golden years, you'll get spanked with ordinary income taxes on the amount plus, in most cases, a penalty of 10 percent.

Of course, investing in an IRA makes sense even if your income is over the $32k cut-off. That's because no matter what your income, the money you invest is able to compound tax-deferred. That means that the income on your gains is not taxable -- even if you choose a Roth IRA, and not until you withdraw your dough (age 59-1/2 or later) if you choose a standard IRA. That's a huge advantage, as the following example shows:

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Two investors, Harvey and Joyce, each begin investing $2,000 a year at age 30. They buy the exact same mutual fund, which returns 10 percent a year, and both are in the 28 percent tax bracket. Harvey invests in the fund through a regular brokerage account, while Joyce sticks it in her IRA. By the time they retire at age 60, Harvey's account has grown to $211,000 -- not bad for an investment of $60,000. But Joyce's $60 grand is now worth a whopping $376,000. That extra $165,000 will be more than enough to pay her taxes when she starts withdrawing.

A Roth IRA offers tax advantages (buzzword again) in a different, usually even tastier proposition. Again, if you've had earned income and made less than six figures as a single person or in the $150k range for married couples, you can bank the same $2,000 away annually. But this time you have to fund the IRA with after-tax money (i.e., your AGI is not lowered by the amount of your contribution). The beauty part is that when you retire, you get all that money, your original contributions and all the interest and earnings, TAX-FREE. Compounded interest, tax-free. What's more, Roth IRAs allow for a wider variety of qualified distributions, or legit withdrawals, prior to retirement age. For example, you can take out up to $10,000 toward the purchase of a first home from a Roth IRA, and the concept can stretch to disability and large medical bills, higher education and other big-ticket items.

Why to care? Well, missy, it's so damn simple: put the coin away now as a young person, let the magic of compounding interest take control. Say you're 25 years old, making $35 large a year. If you make a single contribution of $2,000 to a Roth IRA this year you'd have $90,518 in 40 years, assuming a 10 percent return for stocks during that time. That's saving a mere $167 a month, $38 a week, or a crummy $5.48 saved every day. Even if you can't make the full $2,000 contribution, most IRA plans at brokerages and banks offer reduced minimum account balance requirements and automated monthly deposits for as low as $50 a month from your checking account or paycheck. Peanuts, cakewalk, nada, easy. Do it today.

-- Posted: Jan. 12, 2000

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