Happy birthday, IRA - Many happy returns

Born in the 1970s, these still-overlooked retirement savings accounts have become more useful than ever.

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By Walter Updegrave, Money Magazine senior editor

(Money Magazine) -- It's official: 2009 marks the 35th anniversary of the individual retirement account. I will now pause for a moment as spontaneous celebrations break out across the land.

Okay, so maybe the IRA's birthday isn't cause for dancing in the streets. Still, 35 years after the passage of the law that gave rise to the IRA, a strong case can be made that these retirement plans are more important than ever to workers whose primary investment accounts have been put through the wringer.

Unfortunately, many people are not taking full advantage of these tax-advantaged accounts. Even though most U.S. households are eligible to contribute to an IRA, only 14% did so in 2007.

Part of the problem: Nearly a third of adults aren't sure whether they're eligible, and 40% don't know you can have an IRA and a 401(k) at the same time, says a recent AARP survey.

The fact is, between traditional, nondeductible, and Roth IRAs, almost anyone can contribute to at least one type of IRA.

Find out which account you qualify for - and how much you can contribute - by going to the IRA calculator at Morningstar.com. There are two great reasons to fund one this year and for the 2008 tax year, which you can still do by April 15.

You can use IRAs to make up for lost ground

At a time when 401(k) balances have been hammered, and upwards of 10% of companies plan to suspend or cut back their matching programs over the next 18 months, stashing bucks in an IRA can be a great way to rejuvenate your nest egg.

This is especially true if you're already maxing out your 401(k). Granted, the maximum annual contribution is a modest $5,000 a year (which rises with inflation in $500 increments), plus an extra $1,000 if you're 50 or older. But if you're an older boomer earning $100,000 a year, and your firm stopped matching contributions, $6,000 will probably more than make up for the missing match. And as the chart shows, by funding an IRA over time, you can end up with a six-figure addition to your 401(k).

You can use IRAs to hedge your tax exposure

Chances are, the bulk of your retirement savings sits in tax-deferred accounts, where withdrawals are taxed as ordinary income. This means that if tax rates rise - which is plausible, given how the government is throwing around stimulus bucks - you may wind up with less cash for retirement.

But there's a way to protect yourself: Put some of your stash in a Roth IRA. Besides tax-free withdrawals, a Roth offers other benefits. For instance, you're never required to withdraw money from a Roth as you are with 401(k)s and regular IRAs, so your money can grow tax-free for as long as you like. Plus, Roth withdrawals don't count toward determining whether your Social Security benefits are taxable.

If you have a traditional IRA and your modified adjusted gross income doesn't exceed $100,000, you can convert a portion of your IRA to a Roth. If you earn too much to convert - or to make annual contributions - you can still get money into a Roth: Contribute to a nondeductible IRA (which anyone under 70 with earned income can do) and then convert that to a Roth next year when the income cap for conversions disappears. If your income is too high to contribute to a Roth next year or beyond, don't worry: Just fund a nondeductible IRA and immediately convert.

Many families are changing the way they spend money with regard to their kids in light of the financial crisis. Are you? Tell us how, at makeover@moneymail.com. For the CNNMoney.com Comment Policy, click here. To top of page

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