An individual retirement account, or IRA, is an important tool that can help build your retirement savings. Unlike 401(k)s, which are offered by employers, IRAs are tax-advantaged accounts that offer virtually anyone direct access to investments. When it comes to opening an IRA, it can be helpful to understand the different types of IRAs in order to figure out which one most closely aligns with your unique financial situation and investment goals. Other steps in the process include deciding where to open an IRA, how to fund your account, and what to invest your money in.
Have specific questions about how to open an IRA or retirement planning in general? A financial advisor could provide the answers you seek!
1. Deciding What Type of IRA Is Best for You
When it comes to choosing an IRA, most investors have two basic options, a traditional IRA or a Roth IRA. The annual contribution limits for each of these accounts are the same. For 2024, the IRS caps IRA contributions at $7,000 ($6,500 in 2023), though account holders age 50 and up have a slightly higher limit of $8,000 ($7,500 in 2023). When it comes to taxes, traditional and Roth account contributions are treated very differently.
With a traditional IRA, your contributions may be partially or fully tax-deductible, depending on your income level, filing status, and whether or not you have an employer retirement plan.
In 2024, taxpayers earning over $87,000 (up from $83,000 in 2023), and married joint filers with a workplace retirement plan making more than $143,000 (up from $136,000 in 2023), cannot deduct contributions.
And while you could qualify for a tax deduction upfront, when the time comes 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, because Roth IRAs are funded with after-tax dollars. That means account holders would have already paid taxes on the money that’s being deposited into the account. However, they will have to wait until they are age 59 1/2 or they’ve held the account for five years to make a withdrawal without a penalty. Although those using the money to buy a home for the first time, or for expenses such as college tuition, birth, or adoption, could be eligible for an IRA hardship withdrawal and thus exempt.
It’s also important to note that Roth IRAs have income limits that determine contribution eligibility. Individual taxpayers opening a Roth IRA in 2024 cannot earn more than $161,000 (up from $153,000 in 2023). This limit goes up to $240,000 for married couples filing jointly (up from $228,000 in 2023).
If you’re a small business owner or are self-employed, you also have the option of a SEP IRA or a SIMPLE IRA.
Simplified Employee Pension (SEP) IRAs allow small business owners and self-employed individuals to contribute up to 25% of an employee’s salary or $69,000 per year (whichever amount is the lesser of the two). Once funded, a SEP IRA functions similarly to a traditional IRA.
Owners of a small business with 100 or fewer employees can open a Savings Incentive Match Plan for Employees (SIMPLE) IRA. Once a SIMPLE IRA is set up, employers are required to contribute 2% to 3% each year (3% for matching contributions). Employees can elect whether to contribute or not. To be eligible for a SIMPLE IRA, an employee’s salary must be at least $5,000 for the last two years, and the employee must expect to earn at least $500 in the current year. For 2024, the maximum contribution to a SIMPLE IRA is $16,000 for those under age 50, and $19,500 for those over 50.
Summing up, for those who are younger and expect to be in a higher tax bracket when they reach retirement, opening a Roth IRA could be a good idea. But for those with high-paying jobs who expect their income to decrease in retirement, investing in a traditional IRA (even when they cannot deduct any or part of their contributions) could be a better choice, as their money will continue to grow tax-free until they retire. Small business owners and self-employed individuals have even more options to consider in the form of SEP IRAs and SIMPLE IRAs.
2. Choosing Where to Open Your IRA
You can open an IRA at most banks credit unions, and other financial institutions. IRAs are also available through online brokers, mutual fund providers and other investment companies, such as Vanguard and Fidelity. Of course, each of these options has its respective benefits and downsides.
If you’re a hands-on investor, you might want to open an IRA through an online brokerage. A brokerage could help you generate strong returns, but for this growth, you’ll need to choose your own investments and manage your portfolio. When selecting a brokerage to work with, consider 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’re a more hands-off type of investor, you could consider working with a robo-advisor. Just like with a brokerage, compare fees and services to make sure your needs are met. Many robo-advisors rebalance portfolios and allocate assets automatically to balance risk versus reward. Some may even give you access to a financial advisor.
If you open 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 minimize your risk by guaranteeing your rate of return over time.
3. Opening and Funding Your IRA
Once you’ve chosen the type of IRA you want to open and the provider you want to work with, starting the application process is as easy as going to the company’s website. Some companies may also have a branch you can visit, but it’s often easier to initiate transfers through online services.
When you fill out an application for an IRA, you’ll need to provide certain personal information, like your full name, address, phone number, Social Security number, email address and more.
If you’re transferring funds from your own savings or checking account, you’ll also 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 would instead list your company’s name and address, as well as the manager of your 401(k). The IRA provider can often help with this, and some even have rollover specialists on staff. The process usually involves contacting the 401(k) manager and filling out a few forms. The account balance is then sent to your new provider via check or wire. 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 2024, the IRA contribution limit is $7,000 ($6,500 in 2023), and the catch-up contribution limit for those age 50 or older is $8,000 ($7,500 in 2023). Note that 401(k) rollovers do not count against these limits.
4. Investing the Assets in Your IRA
Opening an IRA at a bank is as simple as deciding on the CD rates and terms that best suit your situation. If the potentially stronger returns of a brokerage-based IRA interest you, you’ll have some other decisions to make.
Once your IRA is set up, the last thing you’ll do is select your investments. This involves choosing from an array of mutual funds, bonds, stocks, exchange-traded funds (ETFs) and more. Those nearing retirement often stick to more conservation options such as bonds, ETFs and cash allocations. Meanwhile, those who are younger often elect riskier options in the pursuit of higher potential 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 can certainly manage your own IRA investment portfolio, it can be helpful to have the help of a financial advisor. 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
Many people may believe that a 401(k) or a high-yield savings account is more than enough when saving for retirement. And while it might be enough for some people, depending on their unique financial situation, an IRA can help to provide an added layer of financial security.
For starters, an IRA is your own personal account, often offering 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 could be a better option.
However, that’s not to say that you shouldn’t open a 401(k) with your employer if they offer one. 401(k)s are extremely valuable tools. They 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. While 401(k)s and IRAs are generally low-risk, they technically aren’t as safe as an interest savings account (which also allows access to cash in the event of an emergency) or a certificate of deposit (CD). In the end, all three of these accounts play an important role in any 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 be what you rely on to take care of yourself and your partner for the rest of your lives. While it can take some time and research to choose the type of IRA and provider that are right for you, it is sure to be time well spent. Even if you have a 401(k) through your employer, an IRA can help increase the funds you’ll have available in retirement.
Retirement Planning Tips
- Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- An IRA gives account holders maximum flexibility, allowing them to manage these accounts on their own. However, this doesn’t mean investors should neglect other retirement savings accounts, like a 401(k). 401(k)s are usually available through an employer, with some employers even offering matching contributions.
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