No more excuses. It’s time to open your first IRA account. We walk you through the entire process, including where to open your account. It’s easy!
Establishing your first IRA, or Independent Retirement Account, is a big deal in the world of finance. This tax-advantaged account is a great way to save and invest for the future. It generally earns more than you would in a high-yield savings account (thanks to compound interest!). And it allows your money to grow tax-free for decades. Aside from a 401(k)–if you have one–it’s the biggest first step you can make toward saving, and planning for a successful retirement.
Planning for retirement is imperative, too, if you don’t want to work for the rest of your life. No matter how much you make now or how much you’ll need in the future, set aside what you can, when you can. Believe me: your future self will thank you!
So, how do you go about deciding on and opening your first IRA? More importantly, how can you start saving in this retirement vehicle with a limited initial contribution?
Let’s talk about the first steps toward opening an IRA. Then we’ll discuss the best ways to fund one if you only have, say, $1,000 to contribute.
Who Can Open One?
First, know that not everyone is eligible to contribute to an IRA. So, who is eligible to establish and contribute to one? If you are younger than 70 ½ and have earned, reported income of any kind, you’re good to go.
The rules for an IRA are simple: you’re can contribute up to the maximum of either the annual contribution limit or your earned income for the year, whichever is lower. The annual contribution limit can change from year to year. For 2018 it’s $5,500 in or $6,500 if you’re over 50.
This means that if you earned $100,000 this year, you can still only contribute up to $5,500 (or $6,500) to your IRA. Conversely, if you only earned $2,500 this year, that is all you can contribute. Even if you have savings elsewhere or your parents want to give you a little extra cash, you can’t put more in the account than you earned in income.
Decide Which Type Is Right for You
There are two types of IRAs to choose from: traditional and Roth. Both are tax-advantaged. This means they both offer tax benefits as they grow. But they work very differently.
Both IRA types have the same contribution limit. You can have both types of IRAs and contribute to both throughout the year. But if you split the money, the combined amount you contribute to both accounts still can’t exceed the applicable maximum.
A traditional IRA lets you see the tax benefits now. You contribute money to this account during the year tax-free. You can contribute pre-tax dollars through your employer. Or you can contribute post-tax income on your own, and then deduct the contributions when you file your taxes.
Your earnings in the traditional IRA will grow tax-free over the years. However, when you withdraw the funds in retirement, you will pay income taxes at whatever your normal rate is at that time.
A Roth IRA is a little different. You will contribute to this fund with after-tax dollars throughout the year. So your employer won’t contribute from pre-tax dollars. And you can’t take a tax write-off for your contribution. Every penny you contribute has already been taxed.
Again, your earnings will grow tax-free over the years. However, when you withdraw funds, you won’t pay any income taxes. None, nada, zip. You’ll be able to withdraw dollar for dollar in retirement (after age 59 ½), without Uncle Sam taking another cut.
So, which one should you choose?
Well, first off, you don’t have to choose. You can certainly open both types, or even open one now to begin contributing and then open the other type later on. However, if you’re asking which would be the better choice for you, here’s the general rule:
- If you think you’re making more money now than you will in retirement, go with the traditional IRA. Taking the tax break now, while you’re in a higher income bracket, is smarter and results in more savings.
- If you think you’ll make more in retirement than you’re making now, go with the Roth IRA. A tax cut now, in the form of annual deductions, doesn’t do you much good if you’ll pay higher taxes on distributions when retirement comes.
Decide when you’re most likely to be in a higher tax bracket, and take the tax benefits then. You can also change this later down the line, if your career shifts and you wind up making substantially more or less than you do now.
Where to Open It
So, you’ve picked an IRA type and set aside some cash. Now, where is the best place to open your account and invest the money? After all, an IRA isn’t simply a savings account, meant to sit around earning a couple percent in interest. It’s a retirement account that you want to grow.
You have a few options available. Almost all major financial institutions offer IRAs. You can open one through a bank or a credit union of which you’re a member. You could turn to mutual fund companies or investment accounts for a more traditional option. Or you can even look into using your IRA to invest with a peer-to-peer lending site, such as Lending Club or Prosper.
You have many, many investment options–more so than with 401(k) investments, in fact. Which you choose is determined by your risk level, your ability to manage the account, and whether you have any specific investment goals.
You can invest your IRA with a robo advisor like Betterment or Wealthfront. These low-cost options can help you decide on a portfolio. They’ll even re-balance your portfolio over time to keep meeting your investing needs.
You could look into utilizing a broker, such as Ally Invest or OptionsHouse. If you want to invest in ETFs (exchange-traded funds) or individual stocks, this is the way to go. This is a great option if you want to pick and choose where your money gets invested.
Mutual fund companies, such as Fidelity, Vanguard, or Charles Schwab are some other preferred places to invest. Each company offers plenty of its own mutual funds to choose from, so you can pick the one that best suits you.
Within the “mutual fund” umbrella, you have a number of options for where your money actually goes. You can pick a target-date retirement fund, which is a fund based on your expected year of retirement. The company will rebalance your portfolio and asset allocation as you go, according to an established timeline. Essentially, the company starts you off in higher-risk, higher-reward investment options when you’re young. As you near retirement, they’ll move your money into safer bonds.
Lifestyle funds are similar, in that they automatically rebalance your portfolio as you go. However, with these, you choose your asset allocation from the get-go, and it doesn’t change over time.
You can also utilize financial advisor services to manage your investments. Each of the mutual fund companies mentioned here offers these services. This is a bit more costly of an option, but can be a great choice if you want to have more control over your money.
Which of these options really depends on your personal preferences and how much money you have to invest. Many companies have initial investment minimums of $0 to $500. But some have minimums of $2,000+. Be sure to check out the details and our reviews before you settle on a company for your first IRA.
Opening and funding an IRA is a great first start toward saving for retirement. It provides more of a return on your savings than a basic savings account would, and also offers tax advantages that help you keep a little more of what’s yours.
By wisely contributing and investing your IRA, you’ll not only grow your money but also save for a successful retirement future. And believe me, you’ll be glad you did.
Published or updated January 29, 2018.