Regular IRA or Roth? Pick either
Think of the last time you bought something that made you very happy — maybe a car, a new pair of shoes, the snowblower that kept you from having a heart attack this winter.
Now, I want you to think of another purchase that will make you smile, but probably not instantly. This one needs to age — even more than a bottle of scotch. But when it's properly aged, it could be even better than getting two cars for the price of one.
I'm talking about individual retirement accounts.
If, for example, you are 30 and put $1,000 into an IRA before April 15 and invest it in a stock market mutual fund, it's likely to turn into about $45,000 by the time you use it for retirement. In other words, it's like seeing this sign in a store: “Get $45,000 for the price of $1,000.”
If you can come up with the maximum of $5,500, it could turn into almost $250,000, or if a 30-year-old stashes away $5,500 a year, it could become about $2.6 million. That's a great deal.
You might have heard that there are traditional IRAs and Roth IRAs and not know which is best for you.
Let me reassure you: Whether you choose a traditional IRA or a Roth IRA, you won't go wrong. Both will grow your money nicely for retirement because the two accounts are set up to keep Uncle Sam away from your money during the years you will be saving. Without having to pay taxes, the money grows powerfully.
The traditional IRA: The traditional IRA is ideal for people who don't think they can scrounge up enough money to save. That's because each year when you plop money into the IRA, the government gives you a tax break that year. So if you put $1,000 into an IRA, in effect it will cost you only $750 because of the tax break you'll get. This assumes you are in the 25 percent tax bracket, although the tax break could be higher or lower based on your income.
Make sure before opening an IRA that your income qualifies for the tax deduction. If you don't have a 401(k) or other retirement savings plan at work, you don't have to worry about income limits. If you do, the cutoff is $69,000 of modified adjusted gross income for singles and $115,000 for couples. See http://www.irs.gov/Retirement-Plans/IRA-Deduction-Limits.
The Roth IRA: Let's say your income is solid, and you are looking forward to it climbing nicely over your lifetime. You are starting to worry about paying high income taxes down the road because you know the federal government is running an enormous deficit and is likely to increase taxes to fund it. Then, the Roth is one sweet deal because no matter what you accumulate, you won't have to pay taxes on it.
People can open Roth IRAs only if their incomes are below a certain level: For 2013, that's $188,000 of modified adjusted gross income for couples and $127,000 for singles. So if your income is creeping close to those levels, make haste and save the maximum $5,500 now — or $6,500 if you're older than 50.
Roths and traditional IRAs contrasted: The beauty of both accounts is that during your working years, you earn money in either account free of taxes, so the money can mushroom. The difference comes on the front end or the back end of your saving years. With the traditional IRA, you get a special tax break each year when you plop money into the IRA. But when you retire, you have to pay taxes on withdrawals.
With the Roth, there's no tax break when you plop money in, but in retirement you don't have to share a cent with Uncle Sam.
Gail MarksJarvis is a personal finance columnist for the Chicago Tribune. Readers may send her email at email@example.com.