3 Smart IRA Moves

By Selena Maranjian Markets Fool.com

The recently released 2017 TIAA IRA surveyoffered some alarming statistics: Less than a third of Americans have an IRA, and only 19% actively contribute to it. It gets even worse: Only 5% contribute more than $5,000 per year to their IRA(s), and nearly a fifth contribute less than $250. Yikes!

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That's terrible news, since so many people are without pensions and need to rely on their own savings for much of their retirement income. Why aren't people making better use of IRAs? Well, nearly half of the survey's respondents said they just didn't have enough money, while a significant 28% said they didn't know enough about IRAs.

Image source: Getty Images.

Don't be among that 28%. Take a little time to learn more about IRAs, what they can do for you, and how to make the most of them. Here are three smart IRA moves.

IRA basics

First, a little background information: There are two main kinds of IRAs -- the traditional IRA and the Roth IRA. With a traditional IRA, you contribute pre-tax money, reducing your taxable income for the year, and thereby reducing your taxes, too. (Taxable income of $65,000 and a $5,000 contribution? You'll only report $60,000 in taxable income for the year.) The money grows in your account and is taxed at your ordinary income tax rate when you withdraw it in retirement.

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With a Roth IRA, you contribute post-tax money that doesn't reduce your taxable income at all in the contribution year. (Taxable income of $65,000 and a $5,000 contribution? Your taxable income remains $65,000 for the year.)Here's why the Roth IRA is a big deal, though: Your money grows in the account until you withdraw it in retirement --tax-free.

Smart IRA move No. 1: Max out your contributions

A critical smart IRA move is contributing as much as you can each year, aiming to hit the contribution limit. The contribution limit for all IRAs is the same for both the 2016 and 2017 tax years -- $5,500, plus an additional $1,000 for those 50 or older.

The more you park in your IRA, the more dollars you'll have that will grow for you. Remember, too, that your earliest invested dollars can do the most for you, as they'll have the most time in which to grow. To get an idea of how much difference just a thousand dollars a year can make to your ultimate results, look at the table below:

Growing at 8% for...

$4,500 Invested Annually

$5,500 Invested Annually

10 years

$70,405

$86,050

15 years

$131,959

$161,284

20 years

$222,403

$271,826

25 years

$355,295

$434,249

30 years

$550,556

$672,902

Calculations by author.

You can aim for even better results, too, by contributing the $6,500 allowed for those 50 and older once you're allowed to. Also, contribution limits are increased every few years. By contributing as much as you're permitted to each year, you can sock away a lot of money for retirement that can provide a much-needed income stream.

Image source: Getty Images.

Smart IRA move No. 2: Choose a Roth IRA

Next, give very strong consideration to a Roth IRA instead of a traditional IRA. For starters, look at the table above again and consider that if those sums were in a Roth IRA, you'd be able to enjoy every single dollar, not losing any to taxes. Yes, a traditional IRA gives you an upfront tax break -- but eventually that money will be taxed, when you withdraw it. (One reason you might prefer a traditional IRA is if you expect to be in a much lower tax bracket when you're retired.)

A Roth IRA isn't necessarily best for all, but if you have many years until you retire, it could have a big edge, as you can reap the long-term effects of compounded growth without being taxed on them. If you're not yet convinced, consider this: The folks at NerdWallet recently crunched some IRA numbers and found that those who contribute the maximum allowed to a Roth IRA will usually, over the long run, end up with more money for retirement than those who maxed out contributions to a traditional IRA (after taxes are accounted for).

Just how much more money a Roth will net you depends on a bunch of factors, such as your tax bracket when you make your contributions and your bracket in retirement. Another key factor when comparing final outcomes is whether the tax savings achieved each year with a traditional IRA contribution are invested. If they are, then the differences shrink. If nothing is done with the savings, as is probably the typical scenario, then the Roth outshines the traditional IRA in most cases. For example, if you're in the 25% tax bracket in retirement, you'd come out $115,227 ahead.

Image source: Getty Images.

Smart IRA move No. 3: Convert a traditional IRA into a Roth

Finally, here's a smart IRA move that many people don't realize is even possible: You can convert a traditional IRA into a Roth. This can be quite valuable if you're still many years from retirement and would prefer that the money you've socked away in a traditional IRA can grow for a long time and be withdrawn tax-free.

If you choose to convert an IRA, you'll have to pay taxes on the value of the assets you transfer in the year of the conversion, but then they'll be in an account that can grow and later be tapped tax-free. A particularly good time to make a conversion to a Roth IRA is when the market tanks and your holdings in your traditional IRA are depressed, leaving less money to be taxed and a lower tax bill. Note that converting to a Roth isn't always the best move. For example, if you'll face steep taxes due to the conversion, that might be a deal breaker.

As you sock away money in order to improve your financial security in retirement, consider making the most of IRAs, as they can be powerful aids. Start early and be disciplined about it, and you can end up with an account worth more than half a million dollars!

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