Starting an IRA (individual retirement arrangement or account) can be one of the best and easiest ways to automate your retirement savings. Unlike with a 401k, an IRA allows you to choose where and what YOU want to invest in – not your employer! Plus depending on where you open an account you’ll also find that the fees are much, much less than what you’re being charged in your 401k account.
Here is how to start an IRA for yourself (and your spouse):
How to Start an IRA – First Decide Which Kind You Want:
The first thing you have to do before you even open your new IRA is to decide exactly what kind of IRA you want. Even though there are a number of different styles, the two most popular ones are:
- A Traditional IRA – The way this one works is very similar to the way a traditional 401k works. For every year you contribute money to your plan, you’ll receive a tax break on that amount. Your savings will then grow tax-free for as long as it is in the IRA. Then once you finally retire and start taking withdrawals to cover your expenses, the money you take out will be taxed as ordinary income.
Because you pay taxes later, this type of IRA is often called a “tax-deferred” IRA.
- Roth IRA – This type of IRA basically works the opposite of a Traditional IRA. You start off by funding the IRA with after-tax earnings (i.e. money you’ve already been taxed on). Your savings then grows tax-free for as long as it is in the IRA. Once you finally retire and start taking withdrawals, the money you take out will be tax-free.
There are endless debates and valid opinions about which one is better than the other. The basic question to help you decide which one is better is to ask:
When I retire which tax bracket do I think I will be in?
If it’s a higher bracket, then the Roth would make sense since you’d be paying lower taxes right now. But if you think you’ll be in a lower tax bracket, then perhaps the Traditional would be a better fit.
Find Out Which IRA You Qualify For:
Once you’ve decided which type of IRA you’d like to open, the next step is to find out whether or not you qualify for one. Unfortunately IRA’s can be restricted by how much your MAGI (modified adjusted gross income) is (this is the number you file every year on your Federal tax return).
For example if your filing is “Married Filing Jointly” and your MAGI is greater than $193,000, then you cannot open a Roth IRA.
For Traditional IRA’s, the requirements are slightly different. At that income level you could participate in an Traditional IRA. However it would not qualify as “non-deductible”; meaning you would not receive a tax-break for that year.
However, that’s nothing to worry about. There is a little known trick called a Backdoor Roth IRA Conversion that allows higher income earners to still legally maneuver their money into a Roth IRA even if their income level exceeds the IRS limits.
All of the income level thresholds for contributing to any type of IRA can be found on the IRS website here.
Get Your Initial Investment Ready to Go:
Go online to any big financial institution (such as Vanguard and Fidelity) and they will almost certainly have a big “Open An IRA” button somewhere to get you started.
Often the required minimum opening deposit is generally somewhere around $1,000. That’s usually just to get the account going. Afterwards you can make subsequent contributions with as little as $50.
If $1,000 is a problem, don’t worry. There is a lot of competition out there for your business. Lots of other online banks and services will allow you to start an IRA with a much lower initial deposit. Just make sure wherever you end up opening your IRA is a place with a good, established reputation.
Pick Out Your Investments:
At the same time you’re opening your IRA, you’ll also need to decide what types of funds you’d like to invest in.
Even though the exact types of funds will depend on where you start your account, there are some generalities you can make about them. For example: Do you want to put your money in stocks? Bonds? A combination of both? Companies like Vanguard and Fidelity can offer all kinds of mutual funds and ETF’s that cover a wide range of assets. If you’re unsure of what to go for, they also have simplified Hybrid and Target Date funds that will automatically pick the right mixture and periodically adjust it as time goes on.
Another thing to consider as you’re picking out your funds is what your comfort level is with risk. For example stocks are known to be much more risky than bonds. But over the long haul they can also produce higher returns. Despite whether or not the long-term payout is higher, the short term fluctuations might not sit well with you. Ultimately it will depend upon your tolerance.
Setup Future Automatic IRA Contributions:
Now that your IRA is open, the last thing you’ll want to do is to keep it funded all year along and beyond. The easiest way to do this is by setting up automatic contributions from your from your savings or checking account each month. Little by little your monthly contributions will help the fund to grow and grow over the years. Though it may seem like a slow process at first, eventually the compounding returns will grow to a significant size. And that will help your overall retirement nest egg in a very big way.
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