IRA Still a Great Tax Break; It’s Not Too Late to Try It

In recent years, many investors have ignored a terrific tax break by failing to fund their Individual Retirement Accounts. If you’re among them, consider making a contribution to an IRA before the April 15 deadline.

Many investors stopped putting money into their IRAs several years ago when Congress decided to limit the deductibility of some contributions. Before then, just about anyone who worked could throw $2,000 annually into an IRA and deduct the full amount from their taxable income.

Now, taxpayers with access to other retirement plans, such as 401(k) savings plans or Keogh accounts, often can’t take that deduction. The amount they can deduct depends on their income.

For example, a single taxpayer who is covered by a company-sponsored retirement plan and has an adjusted gross income of $35,000 or more cannot deduct any part of an IRA contribution.

But don’t let such limitations deter you. IRAs do allow you to shield investment earnings from income taxes. Thus, when you invest in a mutual fund through an IRA, you pay no taxes on the income or capital gains the fund generates until you withdraw the money from the account. Compounding tax-deferred returns can have a tremendous impact on your long-term investment results.

Chuck Carlson, editor of Dow Theory Forecasts, says that an investor who contributes $2,000 annually to an IRA over five years and invests the money in a mutual fund earning 7% annually will accumulate $12,306 in five years, compared to only $11,617 in a taxable account.

After 15 years, the gap widens. You’ll have $53,776 in the IRA and $45,469 in the taxable account. After 30 years, the IRA widens its lead to $202,146 versus $140,537.

Which funds should you choose for your IRA? In general, it makes sense for long-term investors to put money in stock funds. Although such funds tend to be more volatile, they deliver the highest returns over long periods.

An IRA is also a good place to park funds that generate high taxable returns over time. Those include income-oriented funds in your portfolio that generate regular taxable dividends and stock funds that generate high taxable gains because their managers do a lot of trading in their portfolios.