IRAs are important tools for saving for retirement. They’re also befuddling to many investors, with their rules on contribution limits and counting contributions as a tax deduction. Many people mistakenly think an IRA is an investment itself; it’s not, but rather an account that holds your investments.
Even the process of opening an IRA can be confusing, though in many ways it’s similar to opening a bank account. We’re here to walk you through it, step by step.
Where to open an IRA
We’re assuming two things: One, you either don’t have a 401(k), or you’ve already contributed enough to grab any matching dollars offered by your employer — if not, check out this post about the difference between a 401(k) and an IRA and why a 401(k) with match should be your first priority. And two, that you’ve already decided which kind of IRA account you want — traditional or Roth. If you haven’t, do that now. Although we focus on traditional IRAs in this post, the process is similar for both.
First thing: Figure out where to open the account, which means selecting an online broker or other account provider. We’ve put together a list of the best IRA providers to help you choose.
Find the best traditional IRA
- View NerdWallet's top picks.
- Read reviews of account providers.
- Open and fund your account.
In general, you want to look for an account provider that:
- Has low or no account fees.
- Offers a wide selection of no-transaction-fee mutual funds and commission-free exchange-traded funds.
- Provides solid customer service support and investor education resources, especially if you’re a new investor.
- Has low account minimums and fund minimums. These are two separate things: Some online brokers have a $0 initial deposit minimum for IRAs, but their mutual funds require minimum investments of $1,000 or more. Until you build up to that level, your money may sit in a cash account. Look for a broker that will allow you to get started investing right away with the money you have available. (Here’s how to invest $500, and how to invest $1,000.)
You might also consider other factors:
- Are you looking for a managed account? If so, a robo-advisor, which uses a computer algorithm to manage your investments according to your goals, might be a good choice. You’ll pay a small management fee — generally 0.25% or less — but you can sit back and know your investments are in good hands.
- Are you interested in a target-date fund? These mutual funds are another relatively hands-off option, as they automatically rebalance as you get closer to your retirement age. A target-date fund is a “single fund”: You put all of your money in it, and it is diversified among different asset classes. Many IRA account providers offer these, but their expense ratios will vary widely. If this will be your investment of choice, you’ll want to look for a broker with low-cost funds, such as Vanguard.
- Do you plan to trade stocks? You should pay attention to commissions, which can range from $5 to $10 or more. They add up fast and can quickly eat into returns.
- Does the provider offer an IRA promotion or bonus for funding a new account? This shouldn’t be the sole reason you choose that broker, but it can be a good tie-breaker.
How to open an IRA
Once you’ve decided where to open your account, the process of opening an IRA will vary slightly by account provider. But in general:
- Head to the provider’s website.
- Fill in some personal information. The provider will ask for your Social Security number, date of birth, contact information and employment information.
- Select how you want to fund the account — often by transferring funds from a bank account, transferring existing IRA assets, or by rolling over a 401(k). If you’re transferring from a bank or brokerage account, you’ll need the account number and sometimes the routing number.
How to fund your IRA going forward
IRAs have annual contribution limits: In 2016, you can contribute up to $5,500 if you’re under age 50 or $6,500 if you’re 50 or older. These limits cover multiple accounts, so if you have both a Roth and a traditional account, you’ll need to keep your total contributions at or under the maximum.
Traditional IRAs do not have income limits for eligibility, though deductibility of contributions may be limited if you also participate in a workplace retirement plan.
If you’re just starting out, it may be helpful to set up automatic transfers — in other words, you’ll ask your bank to transfer funds into your IRA on a regular basis.
Automatic transfers are the way to go for a few reasons: You get to be lazy and save without clicking any buttons. (No shame in that.) You can set up the transfer for the beginning of the month, before you have a chance to change your mind and, say, do a little late-night infomercial shopping instead. (Maybe a little shame in that.) And perhaps the biggest: Many brokers waive their minimum investment requirements if you agree to automatic deposits of a smaller amount, like $100 or $200 a month. This can help you get in the investing door without a lot of money.
Because of that contribution limit, it takes some math to make sure you’re contributing enough, but not too much. That’s what we’re here for: If you want to spread that $5,500 over a year, contribute $458.33 a month or $105.76 a week. If you’re 50 or older and your limit is $6,500, you can contribute $541.66 a month, or $125 a week.
How to invest your IRA
As we noted above, an IRA is not an investment in and of itself. If you do nothing beyond putting money in the account, you’re not investing — you’re saving.
The aforementioned robo-advisors and target-date funds are a good way to get diversification if you want as little involvement as possible, though they’ll cost you a bit more than building a portfolio yourself.
If you want to get a little hands-on, consider building a portfolio out of index funds and ETFs. To do that, you’ll want to first decide on an asset allocation, or the amount of your portfolio you’d like to divide between riskier investments (like stock funds) and safer, income-producing investments (like bond funds and cash).
The younger you are, the more you’re able to weather market turbulence, which means you have the ability to take more risk with stocks. Note, that’s different from having the stomach for that risk, which should also be a consideration — within reason.
A virtually unlimited investment selection is one good thing about IRAs compared with 401(k)s, which are tightly curated and typically only offer 20 or so fund choices. Once you’ve decided on a stock/bond/cash allocation, you can select specific funds to fulfill that. Many brokers have fund screeners to help you, and you can sort by expense ratio, asset class or any number of other features.
One quick hack to building a portfolio: Check out the portfolios used by robo-advisors (often displayed on their websites) and target-date funds, then mimic them. Just remember that you’ll have to rebalance if things get out of line over time.
Arielle O’Shea is a staff writer at NerdWallet, a personal finance website. Email: aoshea@nerdwallet.com. Twitter: @arioshea.
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