IRA's Vs. Mutual Funds

an IRA is simply an account - an individual retirement account. it is the shell, if you will, and you can use the money inside of the shell to invest in just about anything you'd like, including mutual funds.

you set up the shell first (the IRA), then you deposit funds into the shell, and then you use those funds to purchase assets that hopefully appreciate in value. those assets could be individual stocks or bonds, mutual funds, precious metals, etc. and you can buy and sell freely within the shell without incurring any penalty. the only meaningful limits for most people are imposed by the custodian of the IRA - an entity like vanguard, fidelity or e-trade, for example. those entities might not allow certain investments because they don't offer them.

with a traditional IRA, you deduct the amount you contribute to the IRA from current taxes. when you buy and sell within the shell, you do not incur any taxation. when your investments grow inside the shell you do not incur taxation. when you withdraw funds from the account at retirement, the withdrawal is taxed at ordinary income tax rates (both contributions and growth).

with a roth IRA, you pay tax on the money before contributing. the same rules apply as mentioned above for a traditional, except that there is no tax upon withdrawal at retirement, on either contributed amounts or growth.

any follow-up questions?

OK so lets say that i deposited 3K per year for 20 years. I have 60K in this IRA, lets say its a Roth one since thats what i'm thinking of opening. If I do nothing with the $ in the Roth, then it basically just sits there and ears what, litlle to no interest. Are you saying that a IRA is the "Hub" if you will for me to invest that $ into other things ( mutual funds, etc )? Thanks.

$ Dummy wrote:

OK so lets say that i deposited 3K per year for 20 years. I have 60K in this IRA, lets say its a Roth one since thats what i'm thinking of opening. If I do nothing with the $ in the Roth, then it basically just sits there and ears what, litlle to no interest. Are you saying that a IRA is the "Hub" if you will for me to invest that $ into other things ( mutual funds, etc )? Thanks.

yes, that's right. you would earn no interest at all unless you put the funds into an interest-earning investment such as a money market fund.

OK one more follow up question. Is there an advantage to having a Roth as opposed to just investing my post tax $ into a mutual fund? Or does the $ that goes into something like a mutual fund have to come from a source like an IRA. Thanks.

$ Dummy wrote:

OK one more follow up question. Is there an advantage to having a Roth as opposed to just investing my post tax $ into a mutual fund? Or does the $ that goes into something like a mutual fund have to come from a source like an IRA. Thanks.

Well the advantage that most people see in opening up a Roth IRA is that the money that you are putting into it is untaxed until you decide to withdraw the money at retirement. The money will be taxed at a future date when your tax bracket will probably be different than it is now as well as the tax rate could change in the future. Roth IRAs are also a good instrument for helping people who aren't good at saving on their own. The money is usually automatically deducted from your paycheck before you ever see it and get a chance to spend it.

Personally I don't have a problem saving and I would rather pay the taxes on the money now while I am young and in a lower tax bracket so I don't see the benefit of opening a Roth for myself.

To answer your second question: You can invest your money in mutual funds or anything else for that matter on your own (it doesn't have to go through a Roth). All you have to do is call a mutual fund company (Vanguard and Barclays both have low cost index funds which would probably be good for a novice investor like yourself) and they will walk you through the paperwork you need to fill out.

Before you invest in anything make sure that you do plenty of research on any investment and be fully aware of the risks involved. It would probably be a good idea to read a basic book on investment.

The advise just given to you in the last post is wrong. In fact, it is the exact opposite. A Roth IRA involves putting taxed dollars in the shell account. Therefore, when you withdraw the money when you retire, the gains are not taxed. You are taking the hit now while you are in a lower tax bracket and are not taxed when you withdraw the money.

What the previous poster was talking about was a traditional IRA. With this, tax free dollars are put into the shell and the money is not taxed until you withdraw the money. The benefit to this is that tax free dollars are put in so the money can earn more interest because taxes haven't been taken out. However, you are taxed on the money when you take it out and you will most likely be in a higher tax bracket.

Wow, I shouldn't post until I am totally awake. You are correct.

To the original poster: Moral of the story, go get a basic investing book that covers retirement accounts to properly educate yourself.

there is a cap on the amount of contribution to a traditional IRA that you can deduct, I believe it is $4200. Also, the more money you make that amount gets phases out, its like a penalty for being rich. take advantage of it now, probably won't last long if Dems take over.

Hey taxstudent, why don't you keep the politics out of this until you really understand something about tax law?

$ Dummy wrote:

OK one more follow up question. Is there an advantage to having a Roth as opposed to just investing my post tax $ into a mutual fund? Or does the $ that goes into something like a mutual fund have to come from a source like an IRA. Thanks.

you may have gotten the answer to this from the previous 5 or so posts, but it was a bit muddled. let me try to give you one clear answer.

YES - there is a huge (tax) advantage to investing through an IRA, Roth or traditional, rather than simply buying shares of a mutual fund. (to answer your second question though - there is no requirement that you use IRA money to purchase mutual fund shares).

I mentioned these earlier, but here are the primary tax advantages:

For a traditional IRA:

- you take a deduction now for the amount that you contribute to the IRA. If you contribute $1,000 and your marginal tax rate is 30% (combining federal, state and social security/medicare), you are essentially able to invest $300 more than you would have been able to without using an IRA. That $300 will (hopefully) grow substantially before you retire, so it will (hopefully) end up being a much larger sum of money.

- you do not pay taxes as the money (hopefully) grows. You may think that this is not a big advantage because you plan a "buy and hold" strategy. That's partly true, but even with a buy and hold strategy you will receive dividends and, if you are holding mutual fund shares, capital gains distributions. These would be currently taxable if you held the mutual fund shares directly - this will have a compounding effect over time - less money invested because of the taxes so your investment growth falls behind what it would be inside an IRA. In an IRA, that taxation is either deferred (in a tradiational) or completely avoided (with a Roth).

For a Roth:

- you pay with post tax money now, so there is no current benefit. However, you do not pay tax on the growth of your money. So if you invest $1,000 today and it grows to $10,000 by the time you retire, you can withdraw that $10,000 without paying any tax. If you simply invested post-tax money in a mutual fund outside of an IRA, the growth would be taxed at long-term capital gains rates, which are currently 15% at the federal level (the exception, currently, being that if you die while holding the shares your heirs will inherit with a "stepped-up basis" and they wouldn't pay any tax on the gain if they sold immediately).

- As noted above, the money also grows tax-free inside the Roth.

The same principles apply to a 401(k) or a 403(b) plan.

The primary downside to investing inside a retirement vehicle - IRA/401(k) - is that you can't easily withdraw the money without penalty. Roth IRAs are the most flexible in this regard - you should google for the details. With traditional IRAs you will pay normal tax rates on any pre-retirement withdrawal, plus a penalty of, I believe, 10%.

Let's be clear about some things here:

1) With an IRA, (traditional or Roth) you can't take the money out until you are 59 1/2 years old without paying a 10% penalty. Also, the money you put into an IRA has to be in there for 5 years before you take it out without penalty, but in no case can you take it out BEFORE 59 1/2 without penalty. For example, if you open an IRA at age 57, you have to wait until you are 62 before you can take the money out with no penalty.

2)Not sure where you get the idea that money in an IRA will earn "little or no interest". When you set up an IRA, you pick the types of stock and bonds that you want it to be made up of. My IRA (through Vanguard -- GREAT company!) has returned about 12% each year since I opened it. That money is compounded, so it adds up quickly. For the long haul, figure an 8% return.

3) Mutual Funds are more liquid than IRAs. You can take the money out when ever you want, though you will have to pay taxes on it.

4) General rule of thumb right now is that if you've got less than 20 years before retirement that a traditional IRA is a better choice and that if you've got more than 20 years, a Roth IRA is a better choice. But, there are lots of people who swear by the Roth no matter how long you've got.

I recommend both. Put MOST of your money in an IRA and just a little bit (saving for a rainy day) into a mutual fund or even a money market account -- just a little bit though. The VAST majority of your money should go into retirement accounts.

2007 limits:

401k -- $15,500 per year for those UNDER age 50.

IRA -- $4,500 per year for those UNDER age 50.

If you're over age 50, you get to put in more.

Mutual funds and IRAs are not either/or. As was stated, you can hold pretty much any type of investment in an IRA, including money market, individual stocks, mutual funds, real estate investment trusts, and so on.

If you can contribute to a 401k or 403(b), you should do so. They have the same tax advantage as a traditional IRA - you get the deduction now and the money grows tax-free, but you're taxed when you withdraw it.

The traditional IRA has income limits, and since we've already established that everyone on letsrun makes $250,000 a year and runs sub-14 for 5K, you might not be eligible. So do the Roth. Also, because you'll have so much saved up for retirement, you will still be in a fairly high income bracket when you retire and will have to pay a lot of taxes, but not on your Roth.

FW, you're usually pretty good on these threads, but this post was not your best. It's actually full of inaccuracies, both minor and more meaningful.

This is simply not true for Roth IRAs. It's just not. The following two sources are far from an authoritative source, but they give you an idea of the rules:

The basic idea is that with a Roth IRA you have already paid taxes on the contributions, so there is no "game" to be played to get a tax advantage by putting the money into an IRA and later taking it out. With a traditional, you could defer taxation by doing so, so a penalty makes sense. These sources state that withdrawals of _contributions_ from a Roth IRA are penalty free.

There are also rules that allow early withdrawals of both contributions and gain, without penalty, for certain qualifying events, such as the purchase of a new home. Your 5-year statement does apply here though - the Roth must be at least five years old.

The OP asked whether the money being in an IRA would cause it to earn interest. The answer is clearly that it will not. The investment inside the IRA is what matters - you know that.

Not entirely true - see my response to your first point. And a related point - I want to make sure that people reading this understand that an investment inside an IRA is not a permanent, static investment. You are freely able to buy and sell within the IRA without any penalty. You don't have to pick one stock or mutual fund and hope it does well for 40 years.

This doesn't make any sense at all. It's based on a common misperception that a Roth is better if the assets grow a lot and a traditional is better if they don't. Assuming that you are not intentionally going for a lower or higher rate of return (e.g. you have a traditional that you invest in money market funds and a Roth in risky, high growth stocks) and rather that you are simply choosing Roth vs. traditional and will make the same investment regardless, the choice of Roth vs. traditional has basically nothing to do with expected growth. The choice is based on current and expected future tax rates, "tax diversification", and whether or not you can max out your contribution. We've had threads before discussing this and there are very good online calculators that you can use to determine which type of IRA is right for your situation. This length of time thing is a red herring though.

I certainly recommend a rainy day fund in cash or money market funds. But see my response to number 1 above. With a Roth IRA, the contributions are readily available to you. Therefore, you can leave less in a non-IRA rainy day fund. You still want one though - you don't want to be raiding your Roth IRA on a regular basis. Once you withdraw contributions, you can't replace them. (e.g. you get $4500 for 2007, if you contribute that now and then take it out in 2010, you cannot add the $4500 back in in 2011 - you would only be eligible for 2011's contribution, so that portion of your retirement savings will no longer be tax preferenced. At the same time, if you only contribute $1000 in 2007 out of fear, you also can't add another $3500 in 2011 once things turn out well. You have to balance.)

elwood wrote:

Mutual funds and IRAs are not either/or. As was stated, you can hold pretty much any type of investment in an IRA, including money market, individual stocks, mutual funds, real estate investment trusts, and so on.

If you can contribute to a 401k or 403(b), you should do so. They have the same tax advantage as a traditional IRA - you get the deduction now and the money grows tax-free, but you're taxed when you withdraw it.

The traditional IRA has income limits, and since we've already established that everyone on letsrun makes $250,000 a year and runs sub-14 for 5K, you might not be eligible. So do the Roth. Also, because you'll have so much saved up for retirement, you will still be in a fairly high income bracket when you retire and will have to pay a lot of taxes, but not on your Roth.

You are only taxed on the amount you take out each year, not the amount that you have, so you could have millions, but if you only take out $50,000 per year, you are only taxed on that. For most retirement accounts, you MUST begin to take withdrawals at a certain age (71 or 72 usually), but prior to that, you could decide NOT to take money or just take a very very little.

People always seem to get so geeked about the taxes. Just invest so much so that your payouts are so large that you don't care if you're taxed. You're taxed now on your income -- it will be the same then. If you have a salary of $80,000, you don't TAKE HOME $80,000. You're taxed on that. Same is true in retirement. And, in fact, you get to keep a little more as after you retire you no longer contribute to medicare.

elwood wrote:

The traditional IRA has income limits

Actually, to correct myself, you can always contribute to a traditional IRA, but you don't get to deduct the contribution if you're over a fairly low income limit. The Roth IRA has a much higher income limit, above which you're not allowed to contribute at all.

I think I was told by my guy at Edward Jones that since people are retiring earlier and earlier nowdays, 59 and a half is not the only time you can cash in.

You can do it at 55, but it has to be in a lump sum ..one time a year only....that's the impression I got..then when you hit 59 and a half, the regular rule applies,,

Man, I better get back there and talk to him. I've been investing for many years, have a Roth and will retire in 3 years!

1) always have a cash fund before you start retirement savings, or you will tap into that the first time you have an emergency (lost job, car blows up, etc..) You get KILLED when you make early withdrawls.

2) invest in your company's 401k if it's offered. Especially if they have any kind of company match. Otherwise you are just passing up free money (and a chance to lower your tax rate.)

3) set up your IRA dedections to come out automaticly from your bank account. You'll never miss the money.

2007 contribution limit for Roth IRA is $4000. 2008 contribution limit is $5000. More if over 50.

The IRA is nothing more than a gawddamn terrorist organisation. There's nothing right about what they do. I hope they rot in the bowels of Hades.