Since IRAs are designed to be long-term investments, and can play an important part
in providing a secure retirement, you'll want to have a plan for building your account.
The first rule is to
diversify, which means spreading the assets in a variable annuity among
several different types of
separate account funds. That way you may benefit from owning
some investments that are performing well even if other investments are in a slump.
And you can protect yourself against the risk of depending too heavily on the return
of just one investment category.
One strategy is to use some of your IRA to invest in funds that are designed to
provide income. Since it's a
tax-deferred account, you don't have to worry about increasing
your current tax bill. And you can use the income to make additional investments.
Another approach is to make riskier investments, for example, in separate account
funds that invest in small-company stocks early in your career and gradually shift
the emphasis in your IRA to income-producing investments as you get closer to retirement.
If equity investments have a long time to grow, they have the potential to increase
in value more rapidly than more conservative investments.
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SAVING ON FEES Consolidating your
IRA accounts with a single financial institution can save you money, because you
generally pay an account fee of between $10 and $50 to maintain each IRA. But if
your money is in just one place, there's just one fee. Some institutions waive the
fee entirely if your combined account with them is large enough.
You can let the financial institution deduct the fee from your account, or you can
write a separate, tax-deductible check to cover it. If you write a check, your entire
investment can go on growing.
KEEPING TRACK OF YOUR IRAS While
you can set up a different IRA every year, keeping track of your accounts can be
a nightmare long before you begin figuring your withdrawals. That's another argument
for using one institution. You can have several different types of investments,
but your records will be on one statement that provides all the information you
need.
Since you might have several different types of IRAs in your lifetime—deductible,
nondeductible, and Roth—it's especially important to keep good records. For
example, you don't want to end up paying taxes twice on nondeductible contributions
you've made, as you might if you didn't have records to show their status. The catch
is that you probably need to hold onto the paperwork for as long as you have your
IRAs.
WHEN TAXES ARE DUE As important
as it is to keep your records straight, consolidating your accounts isn't always
the solution. Your Roth IRAs must be held separately from your traditional IRAs,
and your deductible and nondeductible accounts should be separate as well. That's
because when it's time to withdraw, figuring the tax you owe can be a problem.
For example, if, by the time you retire, you have put $40,000 in IRAs—$16,000
in deductible contributions and $24,000 in nondeductible—and together they've
produced $56,000 in earnings, for a current value of $96,000, you must calculate
the taxable portion of the lump sum by subtracting the nondeductible contribution
from the total value.
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THERE'S A HITCH—OR TWO
Chances are you aren't going to withdraw your IRA money in a lump sum. That means
you have to figure out what percentage of the money that has already been taxed
is included in each withdrawal, and compute the tax you owe on the balance. Starting
with a $96,000 balance, you can figure out the taxable part of a $3,000 withdrawal
in three steps.
1. You find the nontaxable percentage by dividing the nondeductible
contribution by the total value of the account.
2. Then you calculate the nontaxable withdrawal by multiplying the
nontaxable percentage from step 1 times the amount of the withdrawal.
3. Finally, you subtract the nontaxable amount from the total withdrawal
to find the taxable amount.
It won't work to say you're using up the nondeductible portion of your savings first.
The IRS says you must treat withdrawals as if they came from all your traditional
IRAs proportionally, even if you have always kept the accounts separate and actually
withdraw from just one.
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