New Year's Resolutions Already Broken? Be Sure To Keep These For Your IRA

By Clifton Linton
Writer, mPower

Ashley Toscano is embarrassed to admit that he usually waits until the last possible moment to deposit money in his SEP-IRA.

"For the last two years, I've waited until the final (tax filing) deadline before putting anything away," he said. In fact, this last-minute planning caused him to miss saving any money in 1997.

But Toscano has made a resolution he plans to keep -- he's going to try putting the money away earlier. He made a good start by making his 1999 contribution in November 1999, rather than waiting until the last minute. That way, he'll have more compound interest working for him over the long run.

This article looks at some financial resolutions that you should resolve to keep, to boost your IRA's performance.

If you haven't done any retirement planning before, now's a good time to start.

According to the Employee Benefit Research Institute's (EBRI) 1999 Retirement Confidence Survey, Americans do a woeful job of planning for their golden years. Fewer than one in 10 workers appears to be doing a very good job of preparing for retirement, EBRI says.

"People who know how much they need for retirement tend to have five times more money in their 401(k) plan than people who don't know," said Dennis Ackley, Vice President of Participant Services with J.P. Morgan /American Century Retirement Plan Services, citing the EBRI study.

Think about what kind of lifestyle you want to have when you retire. Do you plan to work? Will you need to work? Where do you plan to live? Do you plan to travel? These are just a few of the questions you need to ask yourself.

Once you've answered them, then its time to set goals and figure out how to reach them. For example, if you plan to end up with a $100,000 portfolio, will that be adequate?

Using an online calculator offered by the American Savings Education Council, you could quickly estimate your retirement savings needs in 10 minutes, Ackley estimates.

"The goal is building an adequate retirement nest egg," said Ted Benna, the creator of the first 401(k) plan.

One good tool to help you reach your retirement goals is an Individual Retirement Account. With a traditional IRA, you may be able to contribute pre-tax dollars and get a tax deduction now. With either a traditional or a Roth, your profits grow tax-deferred.

Anyone with earned income can open a traditional IRA and take advantage of tax-deferred retirement savings growth. However, if you participate in an employer-sponsored retirement plan such as a 401(k), your contributions to a traditional IRA may not be tax-deductible, depending on your income. In 2000, if you are single and earn $42,000 or more a year, you won't be able to deduct your IRA contribution from your taxes. The same is true if you're married, filing jointly, and earn more than $62,000 a year.

If your income is under $95,000 (single) or $150,000 (married filing jointly) you can open a Roth IRA. Your contributions won't be tax deductible, but you still benefit from tax-deferred compounding.

Suppose you're 25 and invest $1,000 today. Further assume that investment will grow at a 10% rate of return. Let's also assume that you pay a 30% tax rate. In 40 years, by the time you retire, that $1,000 will grow to $14,974, assuming you don't make any additional contributions.

That's not too bad, says Scott Lummer, chief investment officer with mPower Inc. But look at what happens if you can defer, or even avoid, paying taxes on the interest you earn each year. With a traditional IRA, you would only pay tax when you withdrew your money. The final result, after deducting taxes, would be about $30,000. With a Roth, if you met the conditions you wouldn't have to pay tax on your withdrawals, and your final balance would be $45,259. (Keep in mind that your contribution to a Roth is always after paying taxes, so you wouldn't have the benefit of an income tax deduction on your contribution that you might have with a traditional IRA.)

By the way, if you have a 401(k) plan through work, you might want to give your retirement savings an extra jolt by opening an IRA and taking advantage of tax-deferred growth.

Open your IRA as soon as possible in the new tax year. The government gives you until April 15, 2001 to open an IRA for the 2000 tax year, but if you wait that long, you'll miss out on an extra 15 months of interest.

That's why Toscano wants to change his savings habits. "In November, I decided that I should invest ahead of time instead of waiting until April of the following year," he said.

Over time, that extra 15 months of interest can really add up. Knute Iwaszko, author of the book The 401(k) Millionaire: How I Started with Nothing and Made a Million - and You Can, Too, gives the following example. (Unlike the one above, this one assumes that you contribute $2,000 every year to your account.)

If you put $2,000 a year into a traditional IRA over 40 years, and always make your contribution in January (the earliest possible date) rather than 15 months later (the last possible date) you can earn an additional $162,362 in your account, assuming an 11% return.

If your trouble is that you lack discipline to save regularly, you're not alone. But there is a way to put the discipline burden on someone else. By filling out a few simple forms, you can have money automatically shifted from your checking account to your IRA each month.

Beth Randolph, a spokeswoman with J.P. Morgan/American Century, just set up an automatic deduction program for herself. Every month, her employer deducts $83.33 from her paycheck and deposits it into her Roth IRA.

"Once you set it up, it's hassle-free," she said. "It becomes a great budgeting tool because you pay yourself first," she said.

If you're stumped about how to fit retirement savings in with all your other expenses, you need to prioritize your spending. That's what a budget is for.

First, figure out where all your money goes in a month. Then list your spending priorities. You'll see how much you can afford to spend on "luxuries" once you've met your fixed expenses and savings goals. Then, all you need is discipline to follow the budget.

The beginning of the year is a great time to check to see if the funds in your IRA are performing up to your expectations.

If you invest in stocks or mutual funds with a fiscal year coinciding with the calendar year, you should be receiving an annual report fairly soon in the mail. You can read the report to see how the funds are doing. If you don't get one in the mail, you should be able to find most of these reports on the Securities and Exchange Commission's EDGAR site.

This is also the time to make sure your retirement funds are correctly balanced.

Say you wanted to invest 40% of your money in equities and 60% in bonds. Over the last few years, equities have outperformed bonds. It's likely your equity holdings account for more than 40% of your investments. Now's the time to rebalance your accounts.

Most of us haven't rebalanced our retirement accounts since we set them up. "Most people make the decision … and just the let money sit there," said Jim Sullivan, a principal with Arthur Andersen.

As long as you're checking your finances you might want to review your account beneficiaries. If you live in a community or marital property state, your spouse is automatically your beneficiary and you need your spouse to sign a waiver if you want to name a different beneficiary.

Generally speaking you should review your beneficiary list every time you go through a major life event: birth of a child, new job, marriage, divorce, etc.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.