An individual retirement account, or IRA, is a common tool used by those building their retirement savings. IRAs offer both tax advantages and direct access to investments. However, there are a few important considerations that those looking to open an IRA should account for. This includes figuring out what version of an IRA is best for your situation, where you should open your account and what kinds of investments you should invest your money in. If you have specific questions about IRAs or retirement planning in general, consider meeting with a financial advisor in your area.
Tip #1: Figure Out What Type of IRA Is Best for You
Generally speaking, you have two basic options when it comes to IRAs: a traditional IRA or a Roth IRA. The annual contribution limits for each of these account are the same. For 2020, the IRS caps IRA contributions at $6,000, though account holders age 50 and up have a slightly higher limit of $7,000. When it comes to taxes, contributions to traditional and Roth accounts are treated very differently.
With a traditional IRA, your contributions may be partially or fully tax-deductible. This is dependent on your income level, filing status and whether you’re covered by an employer’s retirement plan or not. But when it comes time to withdraw from your traditional IRA in retirement, you’ll have to pay income taxes.
On the other hand, the assets in a Roth IRA grow tax-free. This is because Roth IRAs are funded with after-tax dollars. That means account holders will have already paid taxes on the money they deposit in the account. While that means withdrawals in retirement will be tax-free, you won’t get to deduct contributions from your income now.
If you’re young and you expect to be in a higher tax bracket in retirement, opening a Roth IRA may be a good idea. But for anyone with a high-paying job who expects their income to decrease in retirement, getting an upfront tax break likely makes more sense.
Tip #2: Decide Where to Open Your IRA
You can open an IRA at most banks, credit unions and other financial institutions. However, they are also available through online brokers, mutual fund providers and other investment companies. Each of these options has its respective benefits and downsides, though.
If you set up an IRA at a bank or credit union, your account will probably take the form of an IRA CD. CDs, or certificates of deposit, often have lower yields than investments. On the bright side, they allow you to minimize risk by guaranteeing your rate of return.
For those that open an IRA through an online brokerage, you may end up with better returns. In order to generate this growth, though, you’ll need to choose investments and manage your portfolio. Mutual funds are a popular type of investment, so you could open an IRA with a mutual fund provider too. These accounts can come with high minimums, so make sure you have enough to meet those requirements.
Fees are another factor to take into account before contacting an online broker or mutual fund company. After all, you don’t want fees to take a large bite out of your retirement money.
Tip #3: Choose Your Investments Wisely
Opening an IRA at a bank involves very little decision-making, as you should simply go for the best CD rates and terms you can find. If the possibly stronger returns of a brokerage-based IRA intrigue you, be ready to make some decisions.
After your IRA is all set up, the final piece of the puzzle is choosing your investments. More specifically, you’ll need to select from an array of mutual funds, bonds, stocks, exchange-traded funds (ETFs) and more. If you’re nearing retirement, stick to bonds, ETFs and cash allocations. If retirement is still a ways away though, feel free to be riskier and focus on stocks.
For those that have never invested before, mutual funds and ETFs tend to be the easiest ways to go. A mutual fund typically holds a pool of assets, including stocks, bonds and money market funds. ETFs work similarly, only they tend to focus on specific risk tolerances and market sectors.
Regardless of the type of account you go with, spend some time comparing different IRAs and their various pros and cons. In the end, this will help you choose the account that’s best for your financial needs. Think about working with a financial advisor if you still find yourself having trouble planning your retirement.
Retirement Planning Tips
- Figuring out what kind IRA is best for your retirement plans can be difficult. So don’t be afraid to ask for some professional help. In fact, many financial advisors specialize in retirement planning. SmartAsset’s free matching tool can quickly and easily pair you with up to three advisors in your area. Get started now.
- Although Social Security likely won’t be enough to cover all of your retirement expenses, it can be a valuable addition to your overall income stream. There are many factors to take into account when it comes to planning when you’ll begin taking Social Security payments, so plan accordingly. SmartAsset’s Social Security calculator is a great place to start your planning process.
- An IRA gives account holders maximum flexibility, as these accounts are typically managed on an individual basis. However, this benefit shouldn’t keep you from utilizing other retirement savings accounts, like a 401(k). 401(k)s are usually available through your employer. Some employers even offering matching contributions to help you boost your retirement savings.
Photo credit: ©iStock.com/KaraGrubis, ©iStock.com/mihailomilovanovic, ©iStock.com/BraunS