Why would I want to open an IRA?
 

Okay, I'm doing my taxes for '05 and I am trying to understand the logic behind an IRA. Why would I want to put 40k (I think the maximum is) into an IRA?

Sure, I don't have to pay taxes on it now, but I will when I withdraw it, correct? So what's the point? I either invest it on my own, pay taxes on the principal now, and pay taxes on the interest as I go along or I pay all the tax later (but I can't touch the money for almost 40 years).

I can't see why anyone would want to do this unless their company was matching contributions. As a self-employed person, I don't see the point.

Try to convince me otherwise?

Re: Why would I want to open an IRA?
 

Sadly I'm not an expert, but I believe IRA cotributions are deductible (so you reduce yoru income and play less taxes) and it grows tax free (i.e. the "income" generated between depositing and w/ding when you're 60 or whatever cycles through tax free so more money is going back into the IRA so with compound interest you make more money).

So yeah...it's basically the way to go for long term investments. If your situation is unique (or hell, even if it isn't) you should talk to someone smarter than an internet message board.

J

Re: Why would I want to open an IRA?
 

[ QUOTE ]
Okay, I'm doing my taxes for '05 and I am trying to understand the logic behind an IRA. Why would I want to put 40k (I think the maximum is) into an IRA?

Sure, I don't have to pay taxes on it now, but I will when I withdraw it, correct? So what's the point? I either invest it on my own, pay taxes on the principal now, and pay taxes on the interest as I go along or I pay all the tax later (but I can't touch the money for almost 40 years).

I can't see why anyone would want to do this unless their company was matching contributions. As a self-employed person, I don't see the point.

Try to convince me otherwise?

[/ QUOTE ]

Compound interest(growth) is a beautiful thing. Add tax-free on top of that, you get the picture.

Re: Why would I want to open an IRA?
 

The only thing I am "sort-of" able to get is that instead of paying taxes on the interest each year, all the interest goes back in and compounds, and you pay taxes on the total at the end.

I guess this let's you compound faster, but I'm not sure how much of an incentive that actually turns out to be since I can't touch the money until I'm 60 and I have to pay 10% if I decide I want to use it for something else.

I'm thinking saving to buy a house is the smarter move for now.

Re: Why would I want to open an IRA?
 

Neteller > IRA

Re: Why would I want to open an IRA?
 

(Not trying to be a smartass here just make a point).

Your 60-year old self will need money too, and you probably won't want to work anymore by that point in your life. I also believe you're misunderstanding the tax issue, you only pay taxes on the income you pull out at the end, not income generated (at least I'm 99.9998% certain).

The key is getting the money into your longterm savings as soon as you can, the sooner it gets there the more money you'll make. $10k a year for 25 years at 8% will give you almost a million with only about 1/4 of that being money you actually "spent" on your investment. Not a bad deal.

J

EDITED TO ADD: For comparison sake, $10k/year x 35 years @ 8% would give you about 2 million. See what I mean about starting as soon as you can? Also, you can usually do better than 8% which just makes the piles of money bigger.

Re: Why would I want to open an IRA?
 

Because by delaying paying taxes on your contributions and your interest, you can accumulate interest on money that you otherwise would have paid in taxes.

Suppose your marginal rate is 30%. You have $1000 pre-tax. You invest your money at 10% per year. You can invest $700 today ($1000*(1-t)), and it will turn into about $5,329 after 30 years, assuming you pay taxes annually on the interest accrued.

Now suppose you have the same $1000 pre-tax, but invest it in an IRA, where both your contributions and the interest you earn are tax-deferred. The $1000 turns into $17,449, but you'll have to pay 30% taxes on the entire sum at this point, leaving you with $12,215.

The benefits will be even greater if your current marginal tax rate is higher than the marginal rate you expect to pay when you're retired (a reasonable assumption, since your retirement income will most likely be lower than your current income).

I would actually recommend a Roth IRA over a traditional IRA because you can effectively contribute more per year, since contributions are after-tax rather than pre-tax. Roth IRAs work slightly differently, but it's the same basic logic. With Roth IRAs, you pay taxes on your contributions now, but interest accrues tax-exempt, rather than tax-deferred. Mathematically, as long as your current marginal tax rate is equal to the marginal tax rate you expect to pay when you withdraw the money, there is no difference between contributing $1000 pre-tax or $700 after-tax - they will both accrue to the same $12,215 after taxes. But, you can only contribute $4000 per year (it's increasing every year) to your IRA accounts. Contributing to a Roth IRA effectively allows you more contributions since you're contributing after-tax rather than pre-tax income.

There are also SEP-IRAs, that allow you to save up to 25% of your income, $42,000 max per year. I'd talk to a professional about all of this, but this is the jist of it.

Hope this helps.

Re: Why would I want to open an IRA?
 

You don't pay taxes on the interest you receive from investments. When you withdraw them you pay capital gains on your capital gains.

You can put 4k into a Roth IRA which allows you to put in after-tax dollars and let them grow tax free. I think you can put over 10k into a regular IRA and that is with pre-tax dollars.

This doesn't take into account an SEP, Keough, or Simple. But first off if you're earning under 100k a year and under 30. You need to max your Roth IRA contribution each and every year.

Re: Why would I want to open an IRA?
 

You get to CHOOSE when you want to pay the taxes! There are two kinds of IRAs.

The traditional thinking is that you want to defer taxes now, while you have a relatively high income, and then withdraw the money after you retire to a more modest way of life and fall into a lower tax bracket.

On the other hand, if you are young / poor / already in a low tax bracket now and have aspirations of being rich later... or if you are a cynic who thinks tax rates are going to be significantly higher in 30 years than they are now ... you open a Roth IRA instead of a Traditional IRA, and make after-tax contributions now, so that you can withdraw both principal and interest tax free later.

Re: Why would I want to open an IRA?
 

An additional benefit is that you expect your 60 year old self to be in a lower tax bracket. If not, there's no reason to pull the money out and he can leave it until your 65 year old self wants it, etc.

This could change with the tax code, obviously, but rarely does it change to negatively affect old people who have money (aka voters).

Martin