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How to Open an IRA

An individual retirement account, or IRA, is a popular tool that’s used to help build your retirement savings. IRAs are tax-advantaged accounts, and they offer direct access to investments. There are a few important steps you’ll need to follow if you’re looking to open an IRA, though. This includes figuring out what type of IRA is best for your situation, where to open your account, how to fund it and what to invest your money in. If you have specific questions about IRAs or retirement planning, consider meeting with a financial advisor in your area.

1. Deciding 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 accounts are the same. For 2021, 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 or not you have an employer retirement plan. 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 smart. But for anyone with a high-paying job who expects their income to decrease in retirement, getting an upfront tax break via a traditional IRA likely makes more sense.

2. Choosing Where to Open Your IRA

You can open an IRA at most banks, credit unions and other financial institutions. However, IRAs are also available through online brokers, mutual fund providers and other investment companies, such as Vanguard and Fidelity. Each of these options has its respective benefits and downsides.

If you open an IRA through an online brokerage, you may end up with strong returns. In order to generate this growth, however, you’ll need to choose investments and manage your portfolio. When selecting a brokerage to work with, consider their trading fees and minimums, as well as the quality and usability of their online and mobile platforms. Fees are especially important, as any charges will directly affect your retirement funds.

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, though, they allow you to minimize risk by guaranteeing your rate of return over time.

3. Opening and Funding Your IRA

How to Open an IRA

Once you choose which IRA provider you want to work with, go to the company’s website to start the application process. Some companies may offer branch access, but online services can often be easier to initiate transfers through. These applications will ask for certain personal information, like your full name, address, Social Security number, email and more.

If you’re transferring funds from your own savings or checking account, you’ll need to provide your bank’s routing number and your account number. But if you’re funding your account through a 401(k) rollover, you’ll instead need to list your company’s name and address, as well as the manager of your 401(k). You can also transfer money from another IRA, in which case the provider will ask for that account’s information.

Remember that the IRS limits how much you can contribute to an IRA. For 2021, the IRA contribution limit is $6,000, and the catch-up contribution limit for those 50 or older is $7,000. Note that 401(k) rollovers do not count against these limits.

4. Investing the Assets in Your IRA

Opening an IRA at a bank involves very little decision-making, as you can 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 further decisions.

After your IRA is ready, the final thing to do is choose your investments. More specifically, you’ll need to select from an array of mutual funds, bonds, stocks, exchange-traded funds (ETFs) and more. Those nearing retirement often stick to bonds, ETFs and cash allocations, whereas anyone who’s a ways away from retiring can afford to be riskier in the interest of higher returns.

If you’re new to investing, mutual funds and ETFs tend to be the simplest options. 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. Both are professionally managed for you when you buy into them.

While you’re more than welcome to manage your own IRA investment portfolio, it might be worthwhile to have a financial advisor help you. Advisors can also aid you in building a long-term financial plan that covers things like college savings, estate planning, tax planning and more.

Why Opening an IRA Is Important

How to Open an IRA

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.

Bottom Line

Saving for retirement is one of the most important things you’ll ever do. After all, the funds you accrue before you retire will take care of you and your partner for the rest of your lives. So don’t be afraid to spend some time picking the type of IRA and IRA provider that’s best for your needs. In addition, try to contribute as much as you can to your retirement accounts, as that’ll only boost your potential returns.

Retirement Planning Tips

  • Managing your IRA can be tough on your own, 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 payments. 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, with some employers even offering matching contributions.

Photo credit: ©iStock.com/Casper1774Studio, ©iStock.com/blackCAT, ©iStock.com/gece33

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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