How to Open an IRA

How to Open an IRA

The time to start saving for retirement is now. It’s never too early to begin saving, but don’t wait until it’s too late. If you open an IRA, you can get yourself set up for a financially healthy retirement.

Retirement Savings

Our parents and grandparents had a much better time saving than we do. The dollar was worth more back then. Houses were cheap and you could sell them for 10 times what you bought them for. And employers offered pensions. You would pay a little bit of your paycheck into your employer’s pension. And after a certain length of service at that company, you’d be guaranteed to receive a generous amount of money each month after you retire. They are have Social Security to fall back on.

But gone are the days of cushy government jobs where you put a few bucks into your pension and receive close to you former salary in retirement. And now retirees are living longer than President Franklin D. Roosevelt could have expected when he set up the Social Security Administration. The system wasn’t set up to handle people living 20, 30, or even 40 years after retiring. And with the population constantly growing, Social Security is destined to collapse without serious reform.

So you need to figure out your own retirement.

Your first step should be to check if your employer offers a 401(k) (or 403(b) if you work for a non-profit) and begin contributing to it. Many employers offer to match your contributions to their plan to attract talented workers.

But if your employer doesn’t offer a retirement plan, it’s time to look at opening an IRA.

Related: 401(k) vs. IRA: Which One Should You Choose?

What is an IRA?

An IRA stands for an Individual Retirement Arrangement. It is a specific type of tax-advantaged retirement account. The IRS offers these tax breaks to encourage Americans to save for retirement.

There are also restrictions placed on IRAs in exchange for the tax benefits.

The Internal Revenue Service limits how much you can contribute to an IRA each year. In 2020, the annual limit for IRA contributions is $6,000. If you’re age 50 or older, the limit increases to $7,000.

If you withdraw money from your IRA before you reach age 59 1/2, you’ll also incur an additional 10% tax on the amount you withdrew in addition to it being taxed as regular income.

Traditional IRA vs. Roth IRA

There are two different types of IRAs.

With a Traditional IRA, the money you contribute is tax deductible. The earnings in your traditional IRA accumulate tax free. Once you retire and begin taking distributions from your IRA, you will pay tax on the amount taken out.

A Roth IRA works the opposite way. Money put into a Roth IRA is not tax-deductible. It is money you’re going to pay tax on. The earnings on the account accumulate tax-free and when it comes time to retire, the distributions you take are tax-free as well.

Roth IRAs do have an income limit. If you earn over a certain amount in a year, you’ll have to complete a conversion, sometimes called a backdoor Roth IRA. You contribute to a traditional IRA and convert it to a Roth IRA, or roll-over a portion of your traditional IRA to a Roth IRA. You’ll have to pay tax on the conversion but it provides tax savings in the future.

Which One Should I Choose?

For someone just starting their journey of saving for retirement, either one is a good option. The important part is that you’re saving, not where it’s going

But we can offer some advice.

If you expect you’ll earn more money now than you will when you retire, open a Traditional IRA. This will help you save money in taxes now when you’re putting money into the account

But if you think you’ll be earning more money when you retire than you do now, a Roth IRA is the way to go. You won’t have to pay tax on the money you take out of your Roth IRA when you retire, helping lower your tax bill later in life.

Where Do I Open My IRA?

You can open your IRA at many different locations. The most common IRA custodians are banks and credit unions, investment accounts, robo-investors, and mutual fund companies.

Banks & Credit Unions

Many banks limit your retirement savings to IRA CDs. These certificates of deposit (CD) are low risk investments with guaranteed returns. These are great choices for saving money in the short term while executing part of your investment strategy. They are also great for older folks as there is nearly zero risk in putting your money in a CD.

Banks may have other options for investments. Several banks have an investment division separate from their retail banking counterparts. You can meet with a financial advisor and entrust your money to them. They will have access to all sorts of investment options which can net you bigger returns, but you’ll have to pay management fees for either annually or per transaction.

Online Investment Accounts

Most brokerages allow you to open an IRA online. They typically don’t have a minimum balance requirement and you can purchase investments for much lower fees.

While managing your own investments can sound intimidating, don’t worry too much. Many of these online accounts offer recommendations of what to invest or have suggested mutual funds tailored to your risk appetite.

Robo-Investors

Another online option, robo-investors allow you the convenience of managing your funds online, but will do some of the leg work for you. Answer a few questions and they will invest your money for you. These may come with higher fees as opposed to the DIY options, but are much less than having an actual human managing it for you.

Mutual Fund Companies

Some mutual fund companies allow you to sign up for an account directly with them. You can save money on transaction fees with this method, but they do come with limitations.

You can only invest in that company’s mutual funds. While there may be a couple options, it’s certainly not a wide variety. They will also typically require a sizable investment of at least $2,000 to get started. For people just starting out with retirement savings, this can be a lot to hand over all at once.

Choosing Your Investments

Now that you’ve figured out where to start your IRA, we need to decide what to invest your money in. This can feel like the scariest part. If you have an advisor or broker that you work with, they can take care of this part for you, but if you choose a self-managed account to save some money, it becomes easy to get lost in all the different options.

The first step is figuring out your risk appetite. This is typically based on your age. Younger investors can afford to take more risk, while older investors close to retirement should take big risks as they may lose money. With high risk, can come high reward.

The rule of thumb is to take the number 110 and subtract your current age. This number is the percentage of your investment that should be in stocks. The rest of your investments should be in mutual funds, exchange-traded funds (ETFs), cash, bonds, and other securities.

The goal is not to rely one source for all your earnings. Having a diversified portfolio allows for less risk in a volatile market.

Other companies may have a semi-managed option where they will invest your money in a variety of funds based on your age and how much risk you’re willing to take on. These options are set up to change with you as you get older to keep your portfolio properly diversified so you can retire at a specific age.

Moral of the Story

Start saving for retirement as soon as possible and be diligent about it. Once you start saving, don’t stop. You don’t want to work yourself to death at 80 years old just to be able to eat. Set yourself up for success.

Scott Marcello

Scott Marcello is the founder of CleverWithCash. He's gathered experience in several areas of finance having worked in a bank and as a tax preparer. People have been asking him for years how to get their finances in order. So he figured, why not put the advice all in one place? Thus CleverWithCash was born.

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