Get the Most Out of Your IRA

Whether you're a new investor resolved to start saving for retirement or a long-time IRA owner, now is the time to act if you want to salvage a lousy year or get the most out of your portfolio in the years ahead.

Timing is key. Not only are stocks cheap and contribution limits climbing, but there are moves you can make by year-end or by the tax deadline that can help minimize your tax bill and maximize compounding interest.

Step 1: Invest early in the year

The annual contribution limit for both traditional and Roth IRAs is $4,000. But you'll get even more bang for the buck if you fund your IRA early in the year.

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Many savers have gotten into the bad habit of waiting until the tax deadline to make that year's IRA contribution, says Ed Slott, a CPA in Rockville Centre, N.Y., and publisher of Ed Slott's IRA Advisor. But by putting off until October (with all your extensions) what you could do today, you're giving up a year's worth of tax-deferred compounding (or tax-free compounding in a Roth).

Let's say you're in the 25% tax bracket and want to start an IRA in 2005 with $4,000. If you invested the money on January 2, 2005, regularly contributed $4,000 every January thereafter, and earned an average 8% per year, you'd save about $522,576 in 30 years. However, if you waited until January 2006 to make your 2005 contribution, you'd only earn $478,833.

Step 2: Think long-term

Sometimes, says Brooklyn, N.Y., CPA Barry Picker, retirement savers will use their IRAs as a safe place to park their wealth, rather than actively save for retirement. "People make a mistake of putting it in bank CDs and leaving it there," Picker says. However, you'll get more out of your IRA if you focus on stocks.

Like any portfolio, your retirement account should reflect your investment style and tolerance for risk. But for most people, an IRA is a long-term investment that offers plenty of time for market highs to smooth out the lows.

If you plan to work another 30 years, your IRA can be heavily weighted in stocks, whether you buy them directly or through a stock mutual fund. If retirement is closer, you might want to reduce your exposure to the stock market's volatility by including more fixed-income securities. Kiplinger's Fund Portfolios contain sample portfolios for various time horizons.

Check up on your IRA investments every six months to a year, Picker says, to see how they're performing or to readjust your allocations. But don't micromanage your account. Frequent trades will increase your costs and reduce your long-term returns.

Step 3: Convert or recharacterize

If you've been wanting to swap your traditional IRA for a Roth, but didn't want to bite the tax bullet on conversion, downturn in the market may actually provide an opportunity.

The deadline to convert from a traditional IRA to a Roth is December 31, and your adjusted gross income can't exceed $100,000. You'll have to pay taxes on the converted amount, but the money in the Roth will compound free of taxes. Withdrawals are tax-free, too, and you aren't required to take minimum withdrawals once you reach 70½. See if converting to a Roth IRA is right for you.

If you've already converted to a Roth this year and your income will exceed the $100,000 limit, you can switch back to a traditional IRA before filing your tax return. That's adjusted gross income, not just salary, so it includes wages, taxable interest, dividends and capital gains. If you're hovering very near the cut-off, think of ways to lower your AGI before New Year's -- such as selling losing stocks before the end of the year so you can subtract the capital loss.

You also can save money by recharacterizing your Roth if it has declined in value this year. By switching to a traditional IRA you get to deduct the full $4,000 contribution. Switch back to a Roth later, and you'll face a smaller tax bill.

Step 4: Take care of paper work

"Making money is the same thing as not losing it," says Slott, but many people fail to protect their IRA by not keeping their paperwork up-to-date and accessible. "They spend a lifetime saving but don't take care of who gets (the money) or how it's distributed," he says. This year when you contribute to your IRA, don't forget to protect your investment by taking these simple steps.

• Make sure you have a primary and contingent beneficiary for your IRA, especially if you have children. By naming a contingent (or secondary) beneficiary, your primary beneficiary can choose not to claim the IRA, thus leaving it to the contingent, says Picker. If no secondary beneficiary is named, the entire account must go to the primary beneficiary.
• On the beneficiary form, identify the share of your IRA each beneficiary should receive by specifying a percentage or fraction of the holdings.
• Review your forms once a year to make sure they reflect changes such as marriage, divorce, birth of a child or the death of a beneficiary.
• Let your beneficiaries know where to locate your IRA beneficiary forms. You should keep a copy of the forms and so should your financial advisor or attorney.