The First Thing You Should Do in 2018

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A lot can change in 10 years, but one thing remains the same: The best move to get yourself on the road to a prosperous and financially secure retirement is to open an IRA. The tax benefits of IRAs include the up-front deductions for many taxpayers who contribute to traditional IRAs, tax-deferred growth during the time your savings grow inside the IRA, and tax-free distributions for those who choose Roth IRAs as their retirement vehicle.

There is one wrinkle with IRAs that makes 2018 different from all the other years that I've recommended looking at IRAs. A change in the tax laws that came from the recently passed reform effort in Congress has changed the rules for IRAs, making some worried that you shouldn't be hasty with decisions about retirement accounts. For most people with predictable income, however, there's absolutely no reason to wait and every reason to get started as soon as possible.

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The basics of IRAs

IRAs are simple yet powerful retirement savings tools. Unlike 401(k) and similar plans, which require employer participation, anyone can invest in at least one type of IRA. Contribution limits are relatively generous, with contributions of up to $5,500 each year in 2017 and 2018 for those who are under 50 years old and $6,500 each year for those 50 or older.

One of the biggest advantages of IRAs is that they're one of the few tax planning opportunities that you can use after the tax year ends. You're allowed to contribute to an IRA anytime for a given tax year until the April due date of your tax return. That means that you'll have until mid-April 2018 in order to make a contribution for the 2017 tax year and until April 2019 to make your 2018 contribution.

The downside of IRAs is that you have limited access to your money once you've made a contribution. With traditional IRAs, withdrawals almost always involve having to add the amount taken out of the IRA to your taxable income. You'll usually also owe an additional 10% tax penalty if you make withdrawals before turning age 59 1/2, unless one of several exceptions applies. The need for commitment makes many people leery of putting money in an IRA despite the advantages that come from deferral of income tax on income and gains that the IRA's investments generate.

How to pick the right IRA

Most people can freely choose either a traditional or Roth IRA. Traditional IRAs allow most taxpayers to deduct their contributions, giving them immediate tax savings. Roth IRAs don't provide an up-front deduction, but they typically let you withdraw money tax-free in retirement as long as you meet certain qualifications.

However, income limits apply to both types of IRAs. With Roth IRAs, you're not allowed to make contributions at all if your income exceeds the limits. You can always make traditional IRA contributions, but you can't deduct those contribution amounts if your income is too high.

What tax reform changed with IRAs

The hiccup that taxpayers face in making 2018 contributions to IRAs comes from the recent tax reform bill. A new law takes away one option that those converting from a traditional IRA to a Roth IRA had, and some commentators are nervous that the rule could take away an escape hatch that people have when they contribute to one type of IRA but later need to change their mind.

After a Roth conversion, the old law allowed taxpayers to undo the conversion at a later date. Called recharacterization, this strategy involved taking the Roth money and putting it back where it started. By doing so, you could avoid the tax that Roth conversions generated. Yet some people arguably abused the provision, leading Congress to eliminate it.

For those contributing to a Roth IRA, there are legitimate reasons why you would want to recharacterize your contribution. For instance, if your income is unexpectedly high, then you might make too much to legally contribute to a Roth. If you've done so in anticipation of having lower income, you could find yourself stuck if you can't undo the decision.

Some commentators are nervous that the new law takes away recharacterization in all cases. But by my reading of the law, the change applies only to conversion transactions, not initial regular contributions to a Roth or traditional IRA. If the latter case is OK, then you can freely make a 2018 IRA contribution in early January and be confident that if conditions change, you won't get trapped.

Don't delay!

Saving for retirement is important, and the sooner you get money into an IRA, the sooner you'll start reaping the benefits of tax-favored growth. Resolve to open an IRA early in 2018, and you'll put yourself on the right foot to have a great year.

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