As April 15th rolls around, tax experts are often asked, "Why don't we pay taxes on IRA investments?" An Individual Retirement Account, or IRA, can be an excellent option for saving. A traditional IRA account is not tax-free, rather it is tax-deferred. Traditional IRA investments defer the payment of capital gains tax until the owner begins to withdraw from the account. In other words when someone opens an IRA, they do not pay taxes on it immediately. They keep reinvesting and letting it grow until they retire. Then, when they withdraw the funds during retirement, they do pay taxes on it. They pay higher taxes because the fund has grown, but are usually in a lower tax bracket because their taxable income is much less after retirement.
Sometimes, when clients ask their tax adviser's, "Why don't we pay taxes on IRA investments?" they are told about the benefits of a Roth IRA. Anyone who is more than ten years away from retirement should consider a Roth IRA. This type of IRA can also be used for investment purposes so long as no cash is withdrawn before retirement age. This type of IRA is usually preferred over the traditional kind, because it frees the purchaser from taxes on the accumulated growth.
There are certain trade-offs with buying and investing in an IRA, so the person who wants to know why we don't pay taxes on IRA investments should be informed about the pitfalls. For instance, the IRS strongly discourages people from cashing in their IRAs until they retire. The traditional age for retirement in America at this time is 62. However, some people wait until they are 70, and some retire as early as 55. If anyone decides to withdraw their funds prior to their retirement, they soon find out that their question, "Why don't we pay taxes on IRA investments?" is moot, because they will very quickly be levied a 10% penalty.
Some people believe that they can only invest in CD's within an IRA. However, there are other choices that have greater reward/risk characteristics. The person who does not have a problem accepting additional risks can invest his or her IRA money in stocks or mutual funds. CD investments are safe, but the returns are lower over the long term. Anyone who considers investing in mutual funds or stocks should be well informed about what he or she is getting into. The investor who is not sure about which way to proceed should ask a financial counselor or tax expert. It is important that the person consulted is honest and has a good reputation. Then, ask, "Why don't' we pay taxes on IRA investments?" or any other tax questions that may come to mind.
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