A Truly Valuable Tax-Day Tip

04/18/2011 9:21 am EST

Focus: FUNDS

Terry Savage

Author, The Savage Truth on Money

Attention parents, grandparents, and anyone who knows a young worker who spends all of his or her money: Today is the last day to open a tax-deductible Individual Retirement Account!

If you wish you had saved more, or know someone who should—pass this message along.

Fidelity estimates that nearly half of all IRA contributions they’ll receive for the tax year come in during the last 28 days before the filing deadline. They, and many mutual-fund companies, have telephone representatives standing by to help open an account.

You can open a 2010 IRA with an electronic funds transfer from your checking account, which is a lot easier than it sounds. Or you can actually mail a check, registered mail, with the postmark today—April 18—and it will count as a deduction on your 2010 tax return.

For 2010, you can contribute up to $5,000 to your IRA, and $6,000 if you were age 50 or older by year-end 2010.

Fidelity says the average amount contributed to a Fidelity IRA in 2010 was approximately $3,450, up nearly 9% over 2009 and almost 16% over 2008. (You don’t have to make the full contribution if you can’t afford it, but every little bit will help your retirement.)

The really good news from the Fidelity survey is that younger workers are obviously beginning to realize that they’ll need their own retirement savings. The number of investors under 30 making contributions to a traditional (tax-deferred) IRA increased 16%, as well as nearly 9% more for Roth IRAs—which offers no immediate deduction, but tax-free withdrawals of both contributions and gains in the future.

These numbers increase even further when looking at investors under 25 making contributions, with a 24% increase for both Traditional and Roth IRAs.

You must have “earned income” to make a contribution—although the contribution can come from savings, or as a gift from grandparents or parents who want to get younger workers off to a good start!

Who Can Contribute and Deduct
Although anyone who has earned income and is under age 70 1/2 can open a traditional IRA, not everyone is eligible to deduct an IRA contribution. You’re eligible for a fully deductible IRA contribution if neither you nor your spouse participates in an employer-sponsored plan.

Single filers making contributions to a traditional IRA, and who are covered for any part of the year by an employer-sponsored plan, can only take the full deduction if modified adjusted gross income is less than $56,000 for 2010, while joint filers must have modified adjusted gross income under $89,000 to get the full tax deduction.

If you don’t qualify for a deduction on a traditional IRA, consider a Roth IRA. The income eligibility limits for Roth IRA contributions, which do not create a deduction, start phasing out over $105,000 on a single return and $167,000 on a joint return.

Even if your income is too high to deduct your contribution to a traditional IRA, it is still worth making a contribution for 2010, and getting a head start on your 2011 IRA contribution. All that tax-deferred or tax-free growth can really add up. And that’s the real purpose of contributing to an IRA.

NEXT: Growth Is the Real Benefit

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Growth Is the Real Benefit
Think of it this way. If you contribute $5,000 to an IRA, and over the next 30 years you earn the stock market’s historical long-term average return of 10% (with dividends reinvested), then in 30 years your account would be worth $95,972.

And if you made that $5,000 contribution every year for the next 30 years, growing at the same historical average rate, then in 30 years your account would be worth nearly $1 million!

Now, the stock market doesn’t give guaranteed returns. And you might be skeptical of the market’s future performance based on your recent experiences. But if you had started contributing in the mid-1970s, when IRAs first became available (and the contribution was limited to $2,000), you’d have a nice nest egg today.

It was equally scary to invest in the stock market back in the ‘70s, during the Vietnam War and the energy crisis, which resulted in high inflation. But if you had stuck to your contribution plan, during the ups and downs of the market cycles, you’d be far ahead today.

If you’ve learned this lesson the hard way, find a young person with earned income and urge him or her to contribute to an IRA—today!

The point of opening an Individual Retirement Account is not to turn you into an investment expert, a stock picker, or a market timer. Just invest the money in a broad-based stock market mutual fund that simply reflects market performance.

You could use a S&P 500 stock index fund. Or most fund companies now offer “target-date” funds, invested to become slightly more conservative as you approach your hoped-for retirement year.

The stock market reflects the America into which you hope to retire. You might as well invest in that belief.

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