The IRA: What you need to know

With a traditional IRA, you can receive a tax break this year while saving for retirement. You’ll also enjoy tax-deferred growth on your investments until you withdraw the money from the account at retirement, defined as age 59 1/2 or older. You’ll generally be able to avoid taxes on any contribution you put into the account, meaning it’s a good way to reduce your current taxes.

It’s useful to think of the IRA as a “shield” or “wrapper” on a normal account that protects it from the tax man. Many financial companies offer an IRA, including banks, brokerages, insurance companies and robo-advisors, and each may allow you to make various kinds of investments.

These kinds of investments determine what you’ll ultimately earn in your IRA. If you’re invested in historically strong assets such as stocks, you may do better over time than in CDs and bonds. However, there’s a trade-off to keep in mind – higher-performing investments require you to take on more risk, while safer assets generally fluctuate much less, or in some cases (such as CDs) are risk-free.

You’ll want to read the full details on the IRA so that you’re taking maximum advantage of the plan and avoiding the pitfalls. You may quickly see why it’s such a popular retirement vehicle.

2. Choose where you want to invest

While you have quite a few options for how to set up your Roth IRA, the route you choose depends on how comfortable you are doing things on your own. If DIY is in your DNA, then go online and set up a Roth IRA.

But odds are, you probably have questions an online chatbot can’t answer. If you feel more comfortable working with someone face-to-face, reach out to a SmartVestor Pro. They’re RamseyTrusted investing professionals who can guide you through all your retirement options, including setting up a Roth IRA.

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4. Choose investments within your Roth IRA

So, once you’ve opened your account, your next step is to choose what to invest in. Remember: Your Roth IRA is not an investment in itself—it only holds your investments and protects them from income taxes. You can put all kinds of different investments into your Roth IRA. Choosing your investments is by far the most difficult step in starting a Roth IRA because you’ve got so many options.

We recommend a mix of mutual fundsbecause they allow you to spread your investments across a lot of companies, which lowers your risk while allowing your money to grow. That’s called diversification. If you put all your eggs in one basket (single stocks or trendy investments like cryptocurrency), at some point, you’re going to end up with a mess on your hands.

Here are some other benefits of mutual funds:

  • Mutual funds allow you to use the power of the stock market’s long history of growth without taking on the risk of single stock investing. The stock market historically has an annual average rate of return between 10–12%.2
  • Mutual funds are managed by teams of investing professionals who make sure the mutual fund performs at the highest level possible. They live and breathe this stuff!
  • If you decide to work with an investing professional to open your Roth IRA and choose your mutual funds, the up-front commissions pay for your pro’s time and expert advice—not just at the time you open your account but for as long as you invest in your Roth IRA.

Why Opening an IRA Is Important

Many people may believe that a 401(k) or a high-yield savings account is more than enough when saving for retirement. Although you may be able to get away with that, an IRA can make things a lot easier.

For starters, your IRA will be your own personal account that features a much wider range of investment opportunities than a 401(k) typically does. That’s because 401(k)s often focus on target-date funds, which take a lot of the decision-making out of investing. If you’re looking to maximize your earnings, an IRA is probably your best bet.

However, that’s not to say that you shouldn’t open a 401(k) with your employer if they offer it. 401(k)s are extremely valuable too, as they also receive tax benefits and many employers will provide employees with matching contributions up to a cap. Just as you diversify your investments, you should be diversifying your retirement funds across multiple accounts.

Savings accounts have their place as well. While 401(k)s and IRAs are generally low-risk, they technically aren’t as safe as an interest savings account or certificate of deposit (CD). In the end, though, all three of these accounts should be a part of your retirement savings portfolio.

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2. Choose an IRA Provider

You can open an IRA with many types of financial institutions, including banks, credit unions, investment brokerages and mutual fund providers. You can choose from these four basic options:

  • Savings: Banks and credit unions typically offer IRAs that keep your money in savings or certificates of deposit. The downside is that these accounts will appreciate slowly. The upside: little to no risk. A bank or credit union may also offer investment-based IRAs, including some options listed below.
  • Self-managed investments: Open an investment or mutual fund account and manage your own investments. You may save money in management fees, but beware that fluctuations in the market and constantly changing opportunities aren’t easy for an amateur investor to track.
  • Automated robo-advisor accounts: Although the term “robo-advisor” may sound weirdly futuristic, the process of engaging one is straightforward. You provide information about your risk tolerance, life stage and goals, and the robo-advisor uses complex algorithms to create and manage your investments. You don’t get much human interaction or hand-holding, but you will save a few dollars on management fees while still having an active “eye” on your investments.
  • Professionally managed investments: There’s no doubt that having a live human advisor who can answer your questions, discuss goals and strategies, and actively manage your investments is a great benefit. Finding the right advisor can be a bit of a challenge, however. Be prepared to pay higher fees in exchange for personalized advice. Also, scrutinize any candidate carefully before turning over your money. Be sure you know upfront how fees are structured (flat fee vs. commissions) and how much you should expect to pay.

What are “catch-up” contributions?

A catch-up contribution is an elective deferral to a qualified employer sponsored retirement plan (QRP), such as a 401(k), 403(b), or governmental 457(b), that is made by a participant age 50 or older that exceeds a statutory limit, a plan-imposed limit, or the actual deferral percentage test limit for highly compensated employees. Visit irs.gov for more information.

If you are age 50 or older, you can contribute an extra $1,000 catch-up contribution to an IRA.

How do I choose an IRA?

Though there are several different types of IRAs, you may not be eligible for all of them. Individual taxpayers can choose from traditional and Roth IRAs, while anyone who is self-employed (think freelancers) or a small business owner can choose from SEP (Simplified Employee Pension) and SIMPLE (Savings Incentive Match Plan for Employees) IRAs.

When choosing an IRA to start saving for retirement, you'll most likely be deciding between a traditional or Roth IRA. Key factors to think about are your financial goals, timeline to retirement and risk tolerance. If you're closer to retirement, you'll probably want to go with investments that are lower risk and have less potential to lose money as you near your nonworking years. The advantage of choosing an IRA from a well-known brokerage firm or bank is that they help you assess what would be the best investments depending on your other goals, how soon you want to retire and how conservative you want to be.

For the more active investors, look at IRAs offered by online brokers like E*TRADE. For the more passive investors, consider an IRA from a robo-advisor, such as those from Betterment. Robo-advisors rely on algorithms to manage your portfolio for you, taking into consideration your risk tolerance and goals.

For a more personal experience, consider IRAs offered by big brokerage firms like Charles Schwab, Fidelity Investments and Vanguard that provide access to human advisors.

Can I switch my IRA?

Don’t like your IRA provider? It’s easy to switch your IRA, and you can do so for any reason and at virtually any time. It’s best to transfer your IRA directly from one broker to another.

The steps to transfer your IRA are straightforward:

  1. Open a new IRA account, which will receive the transfer of your current IRA.
  2. Contact your new provider about a transfer. You may be able to transfer your IRA online without any human help, but a customer representative can also help you, if needed.
  3. Complete the transfer forms, typically online or on paper. You’ll need to provide details such as the old provider and account number. If you have investments in your old IRA, your old provider will likely charge you a fee to move them to the new account.

A few days later, securities and cash in your old account will appear in your new account.

You need to be careful when transferring an IRA, because you could create additional taxes if you switch IRA types between a traditional IRA and a Roth IRA. In general, you want to keep the same kind of account. That is, you’ll want to transfer funds from a traditional IRA to another or from a Roth IRA to another, rather than from a traditional IRA to a Roth IRA or vice versa.

If you’re changing account types, it could create significant tax liabilities, and you need to be fully informed about those before making any transfers.

2. Decide Where to Open Your Roth IRA Account

Almost all investment companies offer Roth IRA accounts. If you have an existing traditional IRA, the same company can probably open a Roth IRA for you.

Ask these questions as you decide where to open the account:

  • Is there a fee to open or maintain it?
  • Does the company provide customer service online or by telephone?
  • Does the company offer the types of investments you’re looking for, whether that means exchange-traded funds (ETFs), target-date funds, actively managed funds, or stocks and bonds?
  • How much does it cost to trade? This is especially important if you plan to buy and sell frequently in your account.

The financial institution you open the account with is called a custodian because it takes custody of your money.

Who Can Open a Roth IRA?

As long as you have earned income, you can open and contribute to a Roth IRA. The exception is if your earned income for the year exceeds the limits set by the IRS.

Additional Ways to Invest for Retirement

If you aren’t eligible for a traditional IRA or have exceeded contribution limits for the year, consider opening or funding a regular investment account to grow your money over time. You’ll pay taxes on your earnings and capital gains each year (starting immediately), and your contributions won’t be tax-deductible. But you can contribute as much as you’d like to a regular investment account—and withdraw your money whenever you’d like as well. If you have the funds, this could be an excellent way to grow your retirement nest egg.

You can also invest for retirement by contributing to your employer’s 401(k) or 403(b) plan. Check with your employer for full details. You’ll be limited in terms of where and how you can invest. Still, these accounts are hard to beat if your employer matches your contributions.

Finally, if you’re self-employed, you might consider SEP-IRA or SIMPLE accounts. These are similar to traditional IRAs but have different contribution limits and rules.

Step 3: Open your IRA account

Opening your account is usually pretty simple, and often, can be done online or easily through your brokerage. However, the exact process will vary.

“How you open an account will depend on your selected IRA provider or advisor,” Welsh says. “If you take the do-it-yourself approach, you can likely do it online. If you work with a bank or advisor, you will be provided with forms to open the account, either electronically or in hard copy depending on their processes and your preferences.”

Typically, you’ll be asked for the following documentation and information:

  • A copy of your government-issued ID, such as a driver’s license or passport
  • Your personal information, including your name, phone number, address, date of birth, and Social Security number
  • Details on your beneficiaries, or who you’d like to inherit the account when you die
  • Your preferred contribution method
  • Banking information (if you want to fund the account with an electronic transfer) or information on your other 401(k) or IRAs (if you’re doing a rollover)

If you opt to roll funds over from a 401(k) or another retirement, you’ll also have some forms to fill out there. Some will send the money directly to your new IRA account. Others may send you a check, which you’ll then need to deposit into the new IRA yourself. Typically, the whole process takes anywhere from two to four weeks.

If you rollover funds to a traditional IRA, you won’t need to pay taxes on the funds (until you start making withdrawals). If you roll over funds to a Roth IRA, though, you’ll owe taxes on the rolled-over amount when you file your annual returns. 

Step 1:

Open a Fidelity IRA

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2. Research and select an IRA provider

There are many providers that offer IRAs. When you’re choosing between providers, think about the services and features you want―and how much they cost.

  • Do they offer a wide range of investment options as your needs change—stocks, bonds, mutual funds, annuities, bank products, etc?
  • Will they provide professional investment advice about which options are right for you now and in the future (if you want this service)?
  • Are they friendly, knowledgeable and accessible if you have questions?
  • Do they offer ongoing education and support?
  • Do they have a reputation of financial strength and integrity?
  • What are the fees? Each IRA option will have different fees, such as investment fees and costs tied to different services that come with the account. You’ll want to carefully review the fees to make sure you get the services and features you want for the amount you’ll pay.

When you’ve decided on a provider, contact them to open your account—by phone, online or with the help of a financial professional.

The financial takeaway

IRAs can be a useful tool in planning for retirement. To ensure your IRA investments are as successful as possible, be careful about which type of account you choose and what institution you opt to manage it. 

If you’re not sure or just need guidance, talk to a financial advisor or Certified Financial Planner. They can provide advice personalized to your exact goals and finances.

Aly J. Yale Aly J. Yale is a freelance writer, specializing in real estate, mortgage, and the housing market. Her work has been published in Forbes, Money Magazine, Bankrate, The Motley Fool, The Balance, Money Under 30, and more. Prior to freelancing, she served as an editor and reporter for The Dallas Morning News. She graduated from TCU’s Bob Schieffer College of Communication with a focus on radio-TV-film and news-editorial journalism. Connect with her on Twitter or LinkedIn. Read more Read less

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