For young workers with no employer-sponsored retirement plan – such as a 401k – the reason for opening an IRA looms large: There's no better way to save for retirement. If you do have an employer-sponsored retirement plan, contributing to a Roth IRA provides a better avenue for most younger workers, but there still are plenty of reasons to open a traditional IRA.
Save It or Spend It
What would you do with the money if you didn't put it in an IRA? An IRA contribution whisks your money away from that yawning, gaping hole known as your pocket. Once you stash your cash in an IRA, there are rules – a lot tougher than writing a check or sticking a card in an ATM – that provide impediments for spending the money.
Tax Deduction Now
Your IRA distributions will be taxed as ordinary income in retirement. If you suspect you'll be in a lower tax bracket when you retire, take the deduction now. If your employer offers no retirement plan, all IRA contributions up to the annual $5,000 maximum can be deducted from your adjusted gross income. You might be able to deduct your IRA contribution even if you do have a workplace retirement plan. In 2012, for example, single persons with modified adjusted gross incomes of less than $58,000 can fully deduct IRA contributions and make a proportionate partial deduction up to $68,000. If you're married and file jointly, the full deduction stops when your income hits $92,000 with partial deductions up to $112,000. But if you're part of an unmarried couple, your "joint" income could stretch up to $116,000 before you lose out on the full deduction.
Tax Deferral on Investments
Regardless of your income, you always can make nondeductible contributions to an IRA. You pay no taxes on investment growth – including dividends and capital gains – on IRA investments until you withdraw the money in retirement. After-tax contributions aren't taxed again as part of a qualified distribution as long as you file IRS Form 8606 each year you make nondeductible contributions.
Early Withdrawal Penalty
The threat of an early withdrawal penalty provides another good reason for an IRA. If you take a distribution before you turn 59 1/2, you'll get socked with a 10 percent early withdrawal tax penalty – a psychological deterrent to robbing your piggy bank.
Workplace retirement plans typically offer a dozen or fewer mutual funds as investment choices. IRAs offer a range of investment options, including real estate and commodities, plus stocks, bonds, mutual funds, CDs and savings accounts.
In a regular brokerage account or mutual fund investment, dividends or capital gains create tax consequences that might include shoving you into a higher tax bracket. With assets sheltered in the arms of your IRA, taxes can't get in the way of the best investment decision. You don't need to calculate the tax consequences of dividend yield when considering a stock or let the tax bite discourage you from selling a profitable investment.
If you put money in an employer-sponsored retirement plan, you might not be able to leave it there when you switch jobs. Or you might not like the investment options. Rolling that money into an IRA stands as the only way to rescue that money without tax consequences.
IRAs receive more favorable treatment than regular accounts in many circumstances. Many states have laws protecting IRA assets from creditors and damage claims. Most formulas for determining college financial aid eligibility ignore IRA accounts. IRAs also can provide estate-planning benefits, particularly helpful for unmarried couples.
Dale Bye has spent more than 40 years in journalism, including 25 supervising reporters and editors at metropolitan newspapers and eight years as senior managing editor at a national sports magazine. He directed five newspaper-sponsored personal finance fairs. His fields of expertise include business and personal finance, sports, fitness and theater. Bye holds a Bachelor of Journalism from the University of Missouri.