What We All Assumed You Knew - A Look at IRAs, 401(k)s and Their Place in Your Portfolio - Personal Finance - Financial Education Center for Investors

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What We All Assumed You Knew
Whenever the assumption is made, it is, by default, wrong until proven right. Yet it seems we do it nonetheless. So why do so many fund companies make assumptions about non-investors? Its hard to say. But you are the one we all assumed knew what recent surveys have proven you donšt. With any luck, the following information should help you understand IRAs just a little better.

Can I save on my taxes by opening an IRA?
In the months before April 15th, in 2007, the last day to file your taxes is the 16th, folks begin to wonder if they can save a few dollars from their tax bill by opening an IRA account. While in many instances this is true, the amount saved is not as much as you might imagine. Yet, the benefits of doing so anyway far outweigh the less-than-expected tax write-offs.

Although everyonešs taxes are different, the average savings against earned income by opening an IRA or contributing to an existing one is about 30 to 40 cents per dollar. Many folks, surprised by this fact begin to look for other, more lucrative right-offs,

Don't make that mistake. Consider the maximum contribution for an individual as $4,000. The amount against your earned income might only be $1400 or so but add that to a year over year return of 10%, and that saved cash gains some increased value. Initially, you can think of it as a $5,400 turn around.

So the answer is yes you can.
Some additional things to consider: Folks often make one lump sum contribution when they anticipate a large refund. From an investment standpoint, this is not the best of strategies. If you have the money, do it anyway. Then march yourself into your personnel office and change your tax deductions on your W-4 form. Capture the over paid taxes and use them to fund your monthly contributions. The upside of this is called dollar cost averaging.

Do I have to make the maximum contribution to start an IRA?
Another surprise that surfaced when these surveys were conducted came with the concept of initial deposits. The Fidelity survey found that over fifty percent of those asked believed the only way they could get into an IRA was to come up with the full yearšs contribution at once.

Of course, the reality depends on the mutual fund family you chose but many offer greatly reduced initial contributions if you open an IRA. Taxable accounts held outside of retirement accounts usually cost as much as four times as much to purchase. Fund companies have a number of reasons for doing this.

For the IRA investor, they want to make it as attractive as possible to join and if that happens, it greatly increases the chances that you will set up an automatic deposit at the time of enrollment. Setting up an automatic deposit is the second best thing you can do the first is opening the account.

If you are stumped about which fund to choose, go with an S&P 500 index or a lifestyle fund, one that targets your retirement age. More info can be found here.

For a taxable fund holder, the high price of admission to the same funds usually signals a breakeven point for the fund company and discourages early redemptions.

So the answer is no.
Depending on the fund, the initial contribution rate is usually smaller of investors opening IRAs.

How do deductions work?
Deductibility is the toughest question an investor who was looking to use an IRA to offset their tax bill. First thing to ask yourself is if, as an employee, you are involved in any sort of employer directed retirement account.

Whether you have employer sponsored plan such as a 401(k) or a defined benefit plans also known as a pension, the rules do not allow you to use an IRA if your adjusted gross household income is greater that $50,000 for an individual or $75,000 for a married couple. There is a partial allowable deduction should you exceed those thresholds but the limit is only $10,000 greater for either the single investor or the married couple.

Additionally, if one half of a married couple is a participant in a defined benefit plan and the other is not, then the uncovered spouse can deduct the full amount.

(You may open a Roth IRA a retirement account that has no tax advantage when you open because you can only use money that has already been taxed. While Roth IRAs have additional benefits, the fact that you have already paid the tax on the principle means that at the time you withdraw, the only tax you pay will be on the interest you earn. The income limits for the maximum contribution to these plans is currently $95,000 for a single filer, $150,000 for a couple. There are additional phase out contribution levels up to $110,000 for singles, $165,000 jointly.)

The Pension Protection Act of 2006 may signal the death knell for a great many pension plans in the coming years. This makes the importance of understanding the alternative even more important, if not more urgent.

Are IRAs better than 401(k) plans?
401(k) plans often offer a smaller selection of investments compared to the wide assortment funds available. You should always opt for the 401(k) first especially if there is a company match available. Investors need to understand that the option of both plans is available with some restrictions.

While the selection of funds is much greater, many investors find it easier (tax-wise) to max-out her or his 401(k) plan by having the money removed before the paycheck is in hand. The adjusted take home pay often lowers your tax bracket that, lowers your tax rate.

The answer is yes and no.
Use one or the other. Just use one! If there is money left over, use it to open a Roth IRA further bolstering your retirement savings.