I think this is a great article in the NY Times discussing different type of IRA retirement accounts.  So what are the different types of IRA?

There is a Roth IRA. It allows people under a certin income to contribute taxed dollars to a retirement account.  Currently the amount is $5k/annually, and will grow tax free until retirement at which time the money can still be withdrawn tax free.

This is different from a traditional IRA, where $5k is also contributed annually. But the money goes in untaxed, meaning you don’t pay taxes on the $5k, and it grows tax free until retirement.  Then when you draw distributions in retirement, they are taxed at your current tax bracket.  However, a traditional IRA is only available to people who do not have a 401k available to them at work.

Which is better?   It depends on your income and other retirement options available. 

A third IRA option is a non-deductible IRA. This type of IRA also uses taxed dollars like a Roth for annual contributions.  And these contributions grow tax free, however, when they money is used in retirement the profits are taxed unlike a Roth IRA.  So why would anyone use a non-deductible IRA?  Because you don’t qualify for a Roth or Traditional IRA due to income limitations or employer provided 401k plans. 

The benefit of a non-deductible IRA over a taxable account is that the profits are allowed to grow tax free instead of annually paying taxes on profits.  A second benefit, is if you were laid off or unemployed, that would be the time to convert a non-deductible IRA to a Roth IRA because you would likely be under the $100k income limit conversion.  This income limit will be lifted for one year and one year only 2010.  But whether it is worth doing is questionable. 

However it is definitely worth doing it if you have a very low income (ie no job), because the taxes owed on the conversion would be minimal (10-15%).  As compared to making $150k and adding on an additional $50k of income when converting a non-deductible IRA to a Roth IRA, owing 28-33% federal taxes, and potentially phasing out from contributing to a Roth IRA.

One point mentioned in the article is that IRAs are not as popular as 401k.  People contribute more to a 401k than a Roth IRA even, though a Roth IRA is thought to be a better retirement vehicle.  The article suggests it’s due to employer match in 401ks.

I think that’s one reason, but the real reason is LAZINESS. It’s a lot easier to automate contributions to a 401k. The company sets up the account, takes care of the contribution, and gives you a limited number of investment options.  Whereas setting up your own IRA takes time and paperwork, it’s harder to setup automated contributions and easier to make excuses, and of course since it’s open to picking any investment, I think a lot more frightening.  So people hesistate to contribute. 

I find it a pain to contribute to a Roth IRA, but I know I must.  I can see how someone whose already nervous about investing on their own could be overwhelemed which choices and feel lost with what is the first step.

But if nothing else, at least contribute to any company provided retirement plan, either a 401k or IRA.  It’s better to save something for retirement, even if it’s not the best investment vehicle, than to not save at all.