Tax rebate a good start for retirement plan
By Sandra Block
Starting next month, millions of Americans will receive tax rebate checks ranging from $300 to $600, or $1,200 for married couples. The rebates are intended to rejuvenate the economy by encouraging consumer spending.
But here's a better idea: Use your rebate to jump-start a retirement savings plan.
Consider: If you invest $1,200 in an individual retirement account and continue to save $1,200 a year while earning an average annual return of 8 percent, you'll have more than $21,000 in 10 years. If you use the money instead to buy a flat-screen TV, then 10 years from now, you'll have an old flat-screen TV.
And there's no reason to stop with your tax rebate. This is the time of year when millions of taxpayers receive sizeable refunds from the IRS. So far this year, the average refund is $2,464, according to the IRS. Combine that with your rebate, and you've created a solid foundation for retirement security.
There are, of course, other smart ways to use your rebates and refunds. If you have credit card debt, pay that down first; in effect, you'll reap an immediate return of 18 percent or more. Make sure you have enough in savings to cover your expenses for a few months if you lose your job. And if your employer offers a 401(k) plan, be sure to take advantage of it, especially if your employer offers a company match, says Maliz Beams, executive vice president for TIAA-CREF.
Once you've checked those items off your to-do list, it's time to take a serious look at an individual retirement account. Basically, IRAs come in two flavors:
The maximum contribution for 2007 was $4,000, or $5,000 if you're 50 or older.
Earnings on your investment will grow, tax-deferred, until you retire.
Once you start to take withdrawals, though, you'll pay taxes on the money. And once you turn 70 1/2, you'll be required to withdraw a minimum amount every year.
You don't have to take minimum withdrawals when you turn 70 1/2. And you can withdraw the amount of your contribution at any time without paying a penalty.
Contribution limits for Roth IRAs are the same as those for traditional IRAs. If your AGI exceeds certain thresholds, though, you're not eligible for a Roth.
For 2008, the cut-off for the maximum contribution is $101,000 for singles, $159,000 for joint filers. Singles with an AGI of up to $116,000 and couples with an AGI of up to $169,000 can contribute a reduced amount.
If you don't qualify for a deductible IRA and fall within the income limits, the Roth is your only choice. But what if you qualify for a deductible IRA and a Roth?
For many savers, the benefit of a tax deduction is "hard to give up," says Robin Christian, senior tax analyst for Thomson Tax & Accounting. Remember, though, that you'll have to pay taxes on your deductible IRA when you take the money out. If you're many years from retirement, there's a good chance your tax rate will be higher then than it is now, Christian says.
Roths don't deliver the immediate gratification of a tax break. But the payoff comes later. No matter how much your Roth earns, your withdrawals will be tax-free.
That makes Roths particularly attractive for savers who are still many years from retirement.
"The longer you leave the money in a Roth," Christian says, "the better it becomes."
WHERE TO INVEST
Most mutual fund companies will happily set up a deductible or traditional Roth for you. Unfortunately, many of the fund companies require a minimum investment of $2,000 or more.
You can get around this problem by setting up an automatic investment plan. T. Rowe Price, for example, will let you start with as little as $50, as long as you let the fund company take an automatic withdrawal from your bank account each month until you meet the $1,000 minimum for an IRA.
Investors can avoid Fidelity's $2,500 minimum by agreeing to have $200 a month deposited into an IRA.
Once you've figured out how much you can afford to save, you'll need to tackle an even tougher question: Where's the best place to invest your money?
If you're starting small, look for a fund that offers broad diversification at a low cost. Investors who want a mix of stocks and bonds should consider a balanced fund, says H.K. "Bud" Hebeler, founder of retirement-planning Web site Analyze Now (www.AnalyzeNow.com).
Another low-maintenance option is a target retirement-date fund. These funds allocate your investments based on when you expect to retire. As you move closer to retirement, the fund increases the percentage of your portfolio invested in bonds and reduces your investment in stocks.
Meanwhile, there's no reason to wait until next April to make your contribution for 2008. The earlier you contribute, the more time your money has to compound and grow.
"This is an investment in the future," TIAA-CREF's Beam says. "The earlier you start, the better."
