An individual retirement account, or IRA, comes with some major tax benefits.
Many people open an IRA on top of their employer-sponsored 401(k) as another tool to grow their post-employment nest egg.
If you’re already maxing out the employer match on your 401(k), or if your employer doesn’t offer a 401(k), then an IRA may be the next best option to save for retirement.
It can sound complicated if you’ve never done it before, but don’t let the acronyms and corporate language fool you. Opening an IRA is simple.
How to Open an IRA in 5 Easy Steps
First, choose which type of IRA you want to open. Then decide between a broker or robo-advisor and choose your IRA provider. From there, open your account and start saving.
1. Choose Which Type of IRA You Want
It’s straightforward to open an IRA, but you first need to choose the best IRA type for you. There are two types of individual retirement accounts — Roth IRAs and traditional IRAs.
The biggest difference between a Roth and traditional IRA is how the government treats contributions and withdrawals for tax purposes. Contributions are money you put into the IRA, and withdrawals are money you take out of the IRA when you need it.
When you contribute to a traditional IRA, the contributions are tax-deductible as long as you meet certain criteria. On the other hand, withdrawals from your IRA are taxable. That means when you retire and take money from your traditional IRA, you’ll have to declare it as income on your taxes.
If you have a Roth IRA, the contributions are not tax-deductible. However, you will not be taxed on qualified withdrawals from your Roth IRA.
You can contribute to a traditional IRA as long as you have taxable income and are under the age of 70 ½. A Roth IRA allows you to contribute at any age but imposes income restrictions on contributions.
Both Roth and traditional IRAs allow you to withdraw money at any time but impose a 10% penalty if you withdraw before age 59 ½, although there are a few exceptions.
2. Decide Your Level of Involvement
Once you’ve chosen which type of IRA to open, consider how involved you want to be in managing it. A robo-advisor uses computer algorithms combined with your preferences to manage your IRA investments automatically. Robo-advisors are usually cost-effective. They’re typically good for beginners and hands-off investors.
You can also open an IRA with an online broker, who will execute the buy and sell orders that you give. If you go with a broker, you’ll need to decide what investments to buy and sell. Brokers typically charge per transaction, so the cost will go up if you plan to actively manage your IRA.
You can also pick an in-between option and open an IRA at a brokerage company but choose the funds yourself. You’ll be responsible for buying and selling them, which will take up more time but cost less than paying a broker.
3. Choose Your IRA Provider
Once you’ve decided on your level of involvement, choose your IRA provider, or the company who will hold your IRA account. You have a few options when it comes to providers.
The online marketplace is bursting with robo-advisors. These low-cost, automated investment apps are perfect for the new investor who wants an easy way to get started.
Betterment is one robo-advisor that offers IRA accounts. The app automatically adjusts your investments to stay in line with your financial goals. It charges a fee of 0.25% of your portfolio and has no minimum initial investment.
Online brokers execute your buy and sell orders. Although some may offer market research and investment advice, investors ultimately make the buy/sell decisions. If you want to choose your own investments, then an online broker is the best option for your IRA.
Before signing up with an online brokerage, check the fees and costs per trade. Also, be sure to look at account minimums. Some are as low as $0, but a few brokers require $500, $1,000, or more.
4. Open Your Account
The steps will vary slightly depending on where you decide to open your IRA, but the process is straightforward. At your online broker or robo-advisor, choose the “Open a New Account” option. Make sure that you choose the correct account type — Traditional IRA or Roth IRA.
You’ll need to provide documentation, like a copy of your photo ID, your Social Security Number, bank account routing information, and beneficiaries who will inherit the IRA.
5. Fund Your New IRA
Once you’ve opened your new IRA account, it’s time to put some money into it and start investing. You can fund your IRA from a variety of sources.
Funding from Your Bank or Brokerage
One way to fund your IRA is to transfer money from a bank account you’ve opened online. You can also transfer cash from another brokerage account. Make sure to keep your initial contribution under the maximum for the tax year.
In 2019, the limit is $6,000 or $7,000 for those age 50 or older. If you’re opening a Roth IRA, the maximum may be lower depending on your Annual Gross Income, or AGI.
Rolling Over a 401(k)
When you leave a job, you may also leave behind an employer-sponsored 401(k) account. You’ll gain more investment management choices if you roll your old 401(k) over to an IRA. If you have multiple 401(k) accounts, it can also make sense to consolidate them into one IRA for easier management.
Be very careful to make this a “direct rollover” because the IRS will tax any 401(k) distributions that don’t go to an IRA within 60 days, even if you intend to put them into an IRA in the future.
The $6,000 contribution limit doesn’t apply to rollovers, so you can transfer your entire balance to your new IRA account.
Choosing Your Investments
If you’ve decided to use a robo-advisor, you’re finished. However, if you’ve chosen to open an IRA with a broker, you still need to choose your investments.
You can choose a combination of investments offered by your broker — stocks, bonds, mutual funds and more. As with any investment, make decisions based on your age, expected retirement date, and level of risk. If you’re not sure where to start, it’s wise to consult with a financial planner.
Don’t Just Open an IRA, Make Regular Contributions
Once you’ve opened an IRA, create a plan to make regular contributions. Sit down with your budget and decide how much you want to contribute each month.
If you have the money, contribute the yearly maximum. Transfer $500 to your account every month or earmark a yearly bonus as a lump sum contribution. It doesn’t matter how you contribute at different points during the year as long as your total annual contribution doesn’t exceed the yearly maximum.
Now that you’ve got the basics of how to open an IRA, let’s talk about the finer details.
Where is the Best Place to Open an IRA?
The best place to open an IRA depends on your investing preferences. If you’re busy and want automated investing, a robo-advisor might be best for you. If you prefer to be more hands-on, consider opening your IRA with a broker.
Once you’ve chosen a robo-advisor or broker, research the fees and minimum investments for each option. It’s also important to understand the support and level of flexibility that each platform provides. Ultimately, it’s a personal choice that you need to make based on your research and personal preferences.
Can I Have an IRA and a 401(k)?
Yes, you can have both an IRA and a 401(k). Because both IRAs and 401(k)s have contribution limits, you can take advantage of both types of accounts to maximize your retirement savings.
IRA contributions don’t count against 401(k) limits, and 401(k) limits don’t count against IRA limits. This means that in 2019 you can contribute up to $19,000 in pre-tax dollars to your 401(k) and up to $6,000 to your IRA, depending on income eligibility.
How Much Does it Cost to Open an IRA?
Robo-advisors usually charge a percentage of your portfolio to manage your investments. The more money you have in your account, the more you’ll pay. If you choose an online broker, you can usually open an account for free, but then will pay a flat fee per trade.
Check with the investment company ahead of time if you need help understanding their fees. If you hire a financial advisor, they may charge you a flat rate or a percentage of your total investment.
Can I Open an IRA for My Kids?
You can open an IRA for your kids. However, your child must have earned income to be eligible. Their income can come from either formal employment or self-employment activities like lawn mowing and babysitting.
IRA contributions are capped at the amount the child earned that year or at $6,000, whichever is less. So if your child earned $1,000 babysitting then the maximum IRA contribution for that year is $1,000.
Since children under 18 can’t open brokerage accounts, you will be the custodian of the account until your child is old enough to take responsibility either at 18 or 21 depending on your state.
How Much Should I Contribute to My IRA?
Ideally, you should strive to contribute the maximum allowable amount to your IRA each year. Make sure that you are paying off high-interest debt and contributing to your emergency fund.
You may need to balance other savings goals with your IRA contributions. Even if you can’t contribute the maximum amount, the beauty of compound interest is that every little bit will help you at retirement.
What Kind of IRA Should I Open?
The kind of IRA you choose depends on your financial goals and circumstances.
If you’re married filing jointly and earn more than $203,000 as a household (including income and certain types of deductions), you aren’t eligible to contribute to a Roth IRA. In that case, consider choosing a traditional IRA or ask an investment professional about something called a Backdoor Roth IRA.
Ultimately every financial situation is different. If you’re not sure which option to choose, consult a Certified Financial Planner™ for help.
Do I Need a Financial Planner to Open an IRA?
You don’t need a financial planner to open an IRA. While you may want to consult with a financial planner to help you make some decisions around your IRA, it’s not a requirement.
Opening an IRA is Simple
Many people overcomplicate the process of opening an IRA or procrastinate because they think it’s too difficult. However, opening an IRA is straightforward.
Simply choose the type of IRA you want or are eligible for, decide how involved you want to be, and choose your IRA provider. Robo-advisors are a great option for beginners and hands-off investors. Once you open your account. all that’s left is to make regular contributions.
If you’re still not confident about what to choose or how to get started, speak with a fee-only Certified Financial Planner™. They can help you create a financial plan to meet your goals for a flat, one-time fee.