Remember to Make Your 2012 IRA Contributions by April 15

For good reason, IRAs (individual investment accounts) rank among the most popular tax-sheltered retirement savings vehicles available to U.S. taxpayers.  If purchased outside of a tax-sheltered vehicle, dividend and interest income earned on assets such as stocks, bonds and mutual funds can lead to substantial tax bills each year, even if the proceeds are reinvested.  Tax-sheltered savings vehicles such as IRAs are desirable because along with other account-specific benefits, the U.S. government agrees to relieve you of the obligation to pay these annual taxes in exchange for your commitment to saving for the long-haul.  In order to take advantage of the tax-free savings potential of an IRA, you need to carefully consider four key decisions:  what types of assets you will hold within your IRA, what type of IRA you will use (traditional or Roth), what company you will use as an IRA administrator and how much money you will contribute to the IRA.

First, you need to decide what types of assets to hold within your IRA.  Both traditional and Roth IRAs are merely savings vehicles–there are relatively few limitations regarding the types of assets you can hold within them.   Whereas employer-sponsored 401(K) plans often offer only a small selection of mutual funds, you are able to hold almost any type of financial asset (stock, bond, mutual fund, etc.) within the IRA.  Among other factors, you should consider your age, marital status, household income and number of dependents when deciding which what type of assets to hold within your IRA.  In order to maintain a risk exposure commensurate with your age and lifestyle, make sure to periodically assess and rebalance the relative weights of different assets (and different asset classes) in your portfolio as you age. Generally speaking, the amount of risk you should take with your retirement savings portfolio should decline as you get older, since the older you get, the less time you have make up potential losses.

Next, you need to decide whether to open a traditional or a Roth IRA.  In order to understand the fundamental difference between these two account types, visualize your IRA contributions this year as a seed you are planting; one which you hope will grow to a large crop when it comes time to harvest in retirement.   A traditional IRA requires you to pay taxes on the crop, but not the seed, whereas a Roth IRA requires you to pay taxes on the seed, but not the crop.  Vanguard, Fidelity and Charles Schwab are three of the most highly regarded companies available to serve as your IRA administrator.  Each of these companies accurately summarizes the subtle technical differences between the two account types at the following URLs:

Vanguard:  https://personal.vanguard.com/us/whatweoffer/ira/whichira

Fidelity:  https://www.fidelity.com/retirement-ira/ira/ira-comparison

Charles Schwab:  http://www.schwab.com/public/schwab/investing/accounts_products/accounts/ira/ira_center/ira_account_overview/ira_selector/ira_comparison_chart

Unless you have a crystal ball that will reliably tell you what marginal tax bracket you will face in retirement, you can never be 100 percent certain which account will end up yielding the best after-tax return after all is said and done.  While you would be well-advised to discuss the matter with a qualified tax professional in addition to doing your own research, take note that saving for retirement with an IRA, regardless of whether it is traditional or Roth, is better than saving for retirement in a non-tax-sheltered account.  The worst thing that you can do is get stuck in analysis paralysis and fail to save at all.

If your IRA research leaves you with unanswered questions, you can always consult the ultimate authoritative IRA rule book, IRS Publication 590, at the following URL:

http://www.irs.gov/publications/p590/index.html

For tax year 2012, the maximum contribution for either type of IRA is $5,000 ($6,000 if you are age 50 or older).  Even though 2012 has gone and past, you still have time to do your research and contribute towards your 2012 maximum, as long as you do so by this year’s tax filing deadline – April 15, 2013.