How to Open an IRA in 3 Easy Steps

How to Open an IRA in 3 Easy Steps article image.

Have you saved enough for your retirement? This nagging question can pop up early in life—and it only gets more urgent the older you get. Worse, for most of us there's no magic number that guarantees enough money has been saved for retirement.

This is why opening an individual retirement account (IRA) can be a good move regardless of your current life stage. IRAs let you build a retirement nest egg with benefits that help you save on taxes either now or in retirement. Here are three easy steps you can follow when choosing, opening and funding an IRA account.

1. Decide Between a Traditional and Roth IRA

You have two main choices: a traditional IRA and a Roth IRA. In simple terms, a traditional IRA is more of a "buy now, pay later" proposition. You use pretax dollars to fund it—meaning you may be able to deduct contributions from your income taxes—and defer paying taxes until you withdraw the money in retirement. By contrast, you don't get a tax deduction when you contribute to a Roth IRA; it's funded with income that's already been taxed. As long as you follow eligibility guidelines, however, you don't pay taxes on Roth IRA withdrawals. You can even pass along your Roth IRA tax-free to your heirs.

Here's a chart comparing some of the features of traditional and Roth IRA accounts:

Roth IRA vs. Traditional IRA
Roth IRATraditional IRA
Maximum annual contribution (2021)$6,000 ($7,000 if age 50 or over by end of year)$6,000 ($7,000 if age 50 or over by end of year)
Maximum income allowance$139,999 for individuals filing as single; $207,999 for married couples filing jointlyNone
Contributions tax-deductible?NoMaybe, depending on your income and whether you have a retirement plan at work
Withdrawal of contributions subject to income tax?NoYes
Withdrawal of fund earnings subject to income tax?Maybe, if withdrawals are made before age 59½Yes
Early withdrawal penalty?Some withdrawals of fund earnings made before age 59½ are subject to 10% penalty10% penalty on some withdrawals made before age 59½
Age restriction on contributionsNone70½
Age when distributions become mandatoryNone70½

Which type of account is better for you? Ask yourself three questions:

  • Are you eligible to deduct your contributions? Check the IRS Guide to IRAs for information. Your deductions may be limited if you or your spouse contribute to an employer-sponsored retirement plan such as a 401(k).
  • Are the tax savings worth it? If you have a high income, the tax deduction could be significant. Your tax savings may not be as impactful if your income is lower, however.
  • Would you rather have a tax advantage before or after you retire? With a Roth IRA, you forgo an immediate tax deduction in favor of getting a tax break when you're retired. Getting to keep and spend more of your retirement money will help you maximize the dollars you've saved.

Can't decide? If you're eligible and you have enough funds, you can open both a traditional and a Roth IRA. The contribution limit for both types of accounts is $6,000 annually, with an additional $1,000 if you'll be age 50 or older by the end of the tax year.

2. Choose an IRA Provider

You can open an IRA with many types of financial institutions, including banks, credit unions, investment brokerages and mutual fund providers. You can choose from these four basic options:

  • Savings: Banks and credit unions typically offer IRAs that keep your money in savings or certificates of deposit. The downside is that these accounts will appreciate slowly. The upside: little to no risk. A bank or credit union may also offer investment-based IRAs, including some options listed below.
  • Self-managed investments: Open an investment or mutual fund account and manage your own investments. You may save money in management fees, but beware that fluctuations in the market and constantly changing opportunities aren't easy for an amateur investor to track.
  • Automated robo-advisor accounts: Although the term "robo-advisor" may sound weirdly futuristic, the process of engaging one is straightforward. You provide information about your risk tolerance, life stage and goals, and the robo-advisor uses complex algorithms to create and manage your investments. You don't get much human interaction or hand-holding, but you will save a few dollars on management fees while still having an active "eye" on your investments.
  • Professionally managed investments: There's no doubt that having a live human advisor who can answer your questions, discuss goals and strategies, and actively manage your investments is a great benefit. Finding the right advisor can be a bit of a challenge, however. Be prepared to pay higher fees in exchange for personalized advice. Also, scrutinize any candidate carefully before turning over your money. Be sure you know upfront how fees are structured (flat fee vs. commissions) and how much you should expect to pay.

3. Open and Fund Your IRA

Once you've chosen your account type and provider, you're ready to open your account and start funding it. Check with your provider about minimum contributions. You may be able to open an account with little to no money and fund it electronically from your bank account or paycheck. Choose one of three ways to fund your account:

Make regular automatic contributions. Calculate how much you'd like to contribute annually and divide it by the number of contributions you plan to make in a year. For example, say you'd like to contribute $6,000 in 2021 and you have 12 remaining pay periods before the April 15, 2022, contribution deadline for the 2021 tax year. You can set up an automatic contribution of $500 every payday to reach your goal—and spread out the timing of your investments. If you'd like to keep going for the 2022 tax year, divide your $6,000 by 24 twice-monthly paychecks. You'll contribute $250 each pay period.

You can also make lump-sum contributions. Do you have a few extra dollars in savings or checking? Have you recently had a windfall—stimulus money, a tax refund, a signing bonus? Transfer any amount—up to your yearly contribution limit—directly into your IRA account. Your provider will send you and the IRS Form 5498 showing the yearly total of your contributions, including lump sums, automatic payments and rollovers.

Roll over funds from another IRA or retirement account. If you have another IRA or a 401(k) or other retirement plan with a previous employer, you can usually arrange an electronic transfer from your old account directly into your new one. Alternatively, make sure you maintain a paper trail that shows where the money came from, how much was withdrawn, and the amount deposited into your new IRA (which should equal the amount withdrawn). Documenting these moves will prevent confusion at tax time.

Additional Ways to Invest for Retirement

If you aren't eligible for a traditional IRA or have exceeded contribution limits for the year, consider opening or funding a regular investment account to grow your money over time. You'll pay taxes on your earnings and capital gains each year (starting immediately), and your contributions won't be tax-deductible. But you can contribute as much as you'd like to a regular investment account—and withdraw your money whenever you'd like as well. If you have the funds, this could be an excellent way to grow your retirement nest egg.

You can also invest for retirement by contributing to your employer's 401(k) or 403(b) plan. Check with your employer for full details. You'll be limited in terms of where and how you can invest. Still, these accounts are hard to beat if your employer matches your contributions.

Finally, if you're self-employed, you might consider SEP-IRA or SIMPLE accounts. These are similar to traditional IRAs but have different contribution limits and rules.

More Is Better

Choosing, opening and funding an IRA account (or two) takes a bit of research and initiative, but the benefits you receive may go well beyond the dollars you deposit. With a 5% average annual return, a $6,000 investment today could be worth $44,328 in 40 years, even if you never contribute another dime. Then again, once you've opened accounts and set up funding, it's easy to continue growing your savings, which in turn contributes to a more optimistic and realistic outlook on retirement.

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