NEW YORK (CNN/Money) -
What is the best way to find the right place to open an IRA?
-- Heather Roth, Waukesha, Wisconsin
As we approach the tax-filing deadline of April 15th, money will begin rapidly flowing into IRAs as more and more of us open new accounts or fund existing ones to grab a tax-lowering deduction through a traditional deductible IRA or to take advantage of the tax-free withdrawal feature of a Roth IRA.
And, as a certain celebrity businesswoman now facing possible jail time used to tell us, that's "a good thing." After all, by supplementing our retirement-savings stash with new savings each year, we increase the potential size of our retirement nest egg, as well as the chances that we'll be able to live out our Golden Years with a modicum of security and comfort.
Take time to think about it
Unfortunately, many people give little thought to where they put this annual supplement to their retirement kitty -- or, more specifically, how they invest it.
Indeed, I think for many people the process goes something like this: Drop the tax return in the mailbox, stop by the first bank or other financial institution they pass between the mailbox and their office, and open up whatever CD or mutual fund the salesperson happens to be touting that day. Efficient, perhaps. Smart retirement investing, not likely.
So what's a better way? Well, first, I don't think you should be concentrating solely on the "place" you open your IRA.
These days, most large financial institutions -- whether it's a bank, a mutual fund company or a brokerage firm -- offer a broad enough variety of investments, ranging from CDs to money-market funds to mutual funds to individual stocks and bonds so that you can put together a decent retirement savings portfolio.
In the mutual fund arena, for example, companies like Schwab, Fidelity and Vanguard, just to name a few, offer not only their own house-brand of mutual funds, but also sell their competitors' funds, in many cases through no-sales-fee programs.
That's not to say you shouldn't ask about the fees or sales charges you may incur to open or maintain an account or that you shouldn't take care to choose funds that don't have blimpish annual operating expenses. You should.
But the most important thing is to make sure the IRA you open makes sense in terms of your overall financial picture and your retirement savings strategy.
Toward that end, here are two questions I think everyone should be asking before they invest in an IRA this year.
1. Should I do a traditional deductible IRA or a Roth? With a traditional IRA, you get an immediate deduction that lowers your current tax bill, and then you pay tax on withdrawals. With a Roth, you forego the immediate deduction, but your withdrawals are tax free.
There are lots of rules as to who can fund each type of IRA and what you must do to get the tax benefits each offers. For details, click here.
Generally, you're better off with a traditional IRA if you think you'll be in a lower tax bracket at retirement than you are now. That's because you'll be avoiding taxes now when your rate is higher and paying tax later at a lower rate -- in short, arbitraging tax rates in your favor. If you think you'll be in the opposite situation, the Roth is the better choice. If you think you'll be in the same tax bracket, the two are a wash. For a Roth vs. traditional IRA calculator, click here.
Problem is, if you're still many years from retirement, it's hard to tell what bracket you'll be in. If you save diligently in 401(k)s and other accounts, your withdrawals could drive you into a higher bracket. And there's always the wild card that Congress could simply raise rates in later years.
So unless you're really, really sure whether you'll fall into a higher or lower bracket, I think it's a good idea to have both a deductible IRA and a Roth.
This way you've hedged your bets as far as future tax rates are concerned. And by opening a Roth, you'll also give yourself access to a stash of money you can draw on without paying taxes -- that's a valuable asset in retirement.
You can fund the deductible IRA one year and the Roth the next, or you can fund both in the same year and split your money between the two -- which is perfectly legal as long as the combined contribution doesn't exceed the allowable annual maximum, which is $3,000 for the 2003 and 2004 tax years (plus a $500 catch-up contribution, if you're over 50).
2. How will this year's contribution fit into my retirement savings strategy? Too often, we let recent trends in the market determine how we invest our IRA money. If tech stocks are booming, we plow our money into a tech sector fund. If stocks have been battered, we duck into CDs, money funds or bonds. Or we buy whatever investment the pundits on CNBC are talking about.
That's not a real strategy; it's a recipe for buying investments that are likely at the zenith of their popularity -- and price. A better way is to think in terms of creating an overall retirement portfolio that reflects your risk tolerance and return needs.
If you're young and retirement is far off, you need a portfolio with enough growth potential to create a savings pot large enough to support you in your dotage. That means investing mostly in stocks or stock funds, but also owning a dollop of bonds to dampen stocks' volatility a bit and to prevent you from being dependent on just one asset class.
If you're closer to retirement, you'll probably want to dial down the risk a bit, although you probably still need some of the oomph of stocks in order to keep the purchasing power of your portfolio growing and to assure you don't run out of money. For advice on how to create a diversified portfolio that takes risk and goals into account, click here.
So don't think of your annual IRA contribution as if you're making a new investment in a vacuum. You want to consider the retirement savings and investments you already own -- both in tax-advantaged accounts like 401(k)s and IRAs and in taxable accounts -- and then consider how the new money should fit in.
In short, think of the process of funding an IRA each year not as opportunity just to pick an investment, but to review your retirement savings and investing strategy, and then fine tune it as necessary. As you-know-who might say, it's a good thing.
Walter Updegrave is a senior editor at MONEY Magazine and is the author of "Investing for the Financially Challenged." He also answers viewers' questions on CNNfn's Money & Markets at 4:40 PM on Mondays.