The Average American Doesn't Contribute to An IRA -- Here's Why They Should

By Matthew Frankel Markets Fool.com

Only one-third of American adults have an IRA, and just 18% actively contribute to their account to save for retirement, according to a 2016 survey by financial-services organization TIAA. That means than one in five people take advantage of the massive wealth-building and tax-saving potential of IRA investing. Let's go over why so many Americans are passing on IRAs -- and why almost none of their reasons are good enough to decline such powerful retirement-saving tool.

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Why don't more Americans contribute to IRAs?

Of the 82% of Americans not contributing to an IRA, less than half say they would consider one as part of their retirement strategy. Here are the top reasons this group gave when asked why not.

  • 51% are content with their current retirement plan.
  • 46% don't have money to save more.
  • 25% don't know enough about IRAs.
  • 23% already have a 401(k) or 403(b) plan and don't need an IRA.

To be fair, the first and last reasons could be valid excuses, if the respondent is truly saving enough in their 401(k) or other current retirement plan to provide for their retirement income needs. However, while many experts recommend that workers aim to save 15% of their salary (including employer matches), the vast majority of participants don't even come close to this.

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Even more alarming is that when asked what they would do with an extra $5,000 to spend in one way, just 6% of respondents said they would invest it in a new or existing IRA. Almost half of participants said they would pay down debt or add the money to an emergency fund, which may be a higher priority than investing for retirement. However, a staggering 30% said they would spend it on home renovations, a vacation, a shopping spree, or technology upgrades.

The tax benefits can be fantastic

For most people, there are two main types of IRA to choose from: traditional or Roth. If you have self-employment income, then you may also be able to use a SIMPLE IRA or SEP IRA, so check out those links if you want to learn more.

Traditional and Roth IRAs both have valuable, but different, tax benefits. Both types allow participants to contribute up to $5,500 for both the 2016 and 2017 tax years, with an additional $1,000 allowed if you're 50 or older. (Note: You can make contributions for the 2016 tax year until the April 18, 2017 tax deadline).

Let's start with the traditional IRA. Traditional IRA contributions may be tax-deductible in the year you make them. This can be a pretty big tax break. For example, if you're in the 25% tax bracket, then a $5,500 traditional IRA contribution translates to $1,375 in tax savings for that year. When you make qualified withdrawals from the account, those distributions will be subject to income tax. Note that if you or your spouse can participate in a retirement plan at work, then your ability to take a traditional IRA deduction is subject to income limitations.

On the other hand, contributions to a Roth IRA are not deductible, but your eventual qualified withdrawals will be 100% tax-free. There are a few other benefits to a Roth IRA that you may want to consider. For example, there are no required minimum distributions, and you can withdraw your original contributions without penalty at any time. The ability to contribute directly to a Roth IRA is subject to income limits; you can find the 2017 limits here.

Finally, if you're a low- to moderate-income taxpayer, you may also qualify for the Retirement Savings Contributions Credit(a.k.a. the Saver's Credit), on top of the other tax benefits. In a nutshell, if you file a joint tax return and had adjusted gross income (AGI) of less than $61,500 ($30,750 for singles), you can get a tax credit worth up to 50% of your first $2,000 in retirement contributions per person.

But the long-term savings potential is the biggest reason to open an IRA

I recently wrote an article showing why saving for retirement is the best tax break of all, and for good reason. Not only do you get to take advantage of the benefits I discussed earlier, but you'll be building a retirement nest egg for yourself in the process.

Let's say you choose a Roth IRA, and you contribute $5,000 per year for the next 35 years, which comes to $175,000 altogether. Based on the stock market's historical average total returns, this could grow to a $1.2 million retirement fund in that time. And you'll be able to withdraw every penny of it tax-free, provided you're over 59-1/2 years old at the time.

You don't need much money to get started

Perhaps the biggest misconception people have is that you need thousands of dollars to invest to have any meaningful impact on your financial future. This is 100% false. As you can see if you check out The Motley Fool's IRA Center, many brokerages will allow you to open an IRA with no minimum initial deposit, meaning that you can literally get started with one dollar.

As a final thought, consider this: If you contribute just $20 per week to an IRA for a period of 30 years, based on the stock market's historical rate of return, you could build up a nest egg of more than $155,000. So, if "not having enough money to invest" is holding you back, toss that excuse out the window and get on the path to financial security in retirement.

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