The IRA advantage

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Top things to know What should I do first? How should I invest? The virtues of the 401(k) The IRA advantage What to do when you switch jobs How can I get the most out of my money in retirement?

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Whether you have a 401(k) or other tax-advantaged savings plan at work, consider investing in an IRA to augment your retirement savings plan.

As with a 401(k), you don't pay taxes each year on capital gains, dividends, and other distributions from securities held in your IRA. Beyond that, there are different tax advantages, depending on which type of IRA you open.

There are two types: a traditional IRA offers tax-deferred growth, meaning you pay taxes on your investment gains only when you make withdrawals in retirement, and, if you qualify, your contributions may be deductible.

A Roth IRA, by contrast, doesn't allow for deductible contributions but offers tax-free growth, meaning you owe no tax when you make withdrawals in retirement.

A traditional IRA comes in two flavors: deductible and nondeductible. To see if you qualify for a deductible IRA, which lets you deduct all or part of your contributions from your taxable income, use the following guidelines:

• If you have no retirement plan at work and you're under 70-1/2, you can invest in a deductible IRA and deduct the entire amount from your taxes.
• If you have a 401(k) or other retirement plan at work, you may fully or partially deduct your contribution only if your adjusted gross income (AGI) qualifies. (These income limits reset at $65,000 for singles and $109,000 for couples by 2009.)
• If you're not covered by a retirement plan, but your spouse is, you may qualify for a full or partial deduction if you file jointly and your AGI is below $176,000 for the 2009 tax year. (The same rule applies if you're a non-working spouse of someone covered by a retirement plan at work.)

If you're not eligible to contribute to a deductible IRA, you may be eligible to contribute to a Roth IRA if your AGI is below $120,000 if you're single or $176,000 if you're married and filing jointly. If you are age 50 by Jan. 31, 2009, the maximum IRA contribution limit for 2009 is $6,000; otherwise, the max is $5,000.

If you make too much to qualify for a Roth IRA and are not eligible for a deductible IRA, a nondeductible IRA is a valid option. Your contribution won't be deductible, but at least your savings will grow tax-deferred.

So which IRA is best for you? The nondeductible is the least attractive, so open one only if you don't qualify for the other two. If you have a traditional IRA, you may want to consider converting it to a Roth in 2010, especially if you made non-deductible contributions.

The Tax Increase Prevention and Reconciliation Act of 2005 permanently removes the $100,000 income ceiling for Roth conversion eligibility. For conversions in 2010, 50% of the income is taxed in 2011, and 50% in 2012, a one time opportunity.

The choice between a deductible and a Roth is more difficult, but generally you're better off in a Roth if you expect to be in a higher tax bracket when you retire.

Plus, the Roth offers more flexibility: You are not required to make mandatory withdrawals from your account when you turn 70 1/2 - as you are with other IRAs - making the Roth a great way to leave money to your heirs.

Further, if you need the money before retirement, there are more opportunities for penalty-free withdrawals.

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