A Roth IRA is a true gift from the IRS: While there’s no immediate tax benefit, distributions in retirement are completely tax-free.
But the process of opening these accounts can be a roadblock that keeps investors from taking advantage. Because of the huge tax benefits, there are a lot of rules for Roth IRAs, including contribution limits and income thresholds (along with backdoor and conversion strategies to sidestep them).
Here’s a step-by-step guide to starting a Roth IRA:
Where to open a Roth IRA
A couple of things to get out of the way here: If you have a 401(k) that offers matching dollars and you’re not contributing enough to earn them all, that’s where you should direct your retirement savings first. (Want to know more about this? Read our Roth IRA vs. 401(k) post, which explains the differences between the two accounts and how you should prioritize them.)
We’re also going to assume, for the purposes of this post, that you’ve already compared the differences between a Roth and a traditional IRA and you’ve landed on the Roth (which is, indeed, the best option for many people). That’s the type of IRA we’re referencing in this post, though much of this advice applies to both types.
Look for an IRA provider that:
- Has low or no account fees.
- Offers a large selection of no-transaction-fee mutual funds and commission-free exchange-traded funds.
- Provides strong customer service and investor education, especially if you’re new to investing.
- Has a low account minimum and low fund minimums — these are two separate things. We’d hate for you to choose an online broker because it has no initial minimum deposit, only to realize later that most of the funds you want to invest in require $1,000 or more. Your money would likely have to sit in cash until you built up enough to buy in at the minimum level.
Once you’ve narrowed it down to a few, you should also consider other factors:
- Are you looking for a managed account? You might want to open your IRA at a robo-advisor. Robo-advisors use a computer algorithm to manage your investments according to your goals, so you can sit back and do mostly nothing. You’ll pay a management fee of around 0.25% on top of any fees charged by the funds used (robo-advisors tend to use low-cost ETFs).
- Do you want to trade stocks? You’ll want a broker with low commissions.
- Are you interested in a target-date fund? Before robo-advisors, these were the primary way for investors to be hands-off for a relatively low fee. Target-date funds are diversified funds that automatically rebalance to take less risk as you get older. Because of that diversification, you put all of your money into the one fund rather than spreading it among multiple funds.
- Are you eligible for a sign-up promotion or bonus? Many account providers offer these to new customers, though you may need to meet a certain deposit requirement. Don’t make a decision solely based on a promotion, but do take a look at the offers as you shop around.
Find the best Roth IRA
- View NerdWallet's top picks.
- Read reviews of account providers.
- Open and fund your account.
How to open a Roth IRA
You’ve landed on the best home for your account — now what do you do about it? The provider will be more than happy to walk you through the process of handing over your money, but here’s a quick guide:
- Visit the provider’s website.
- Fill in your personal information. You’ll likely be asked for your Social Security number, date of birth, contact information and employment information.
- Set up funding to the account. You can make a funds transfer from a bank account, move over existing IRA assets, or roll over a 401(k). If you’re transferring from a bank or brokerage account, you’ll need the account number and, in some cases, the routing number.
How to fund your Roth IRA going forward
Roth IRAs have contribution maximums and income eligibility limits, as noted above. In 2016, the maximum contribution is $5,500 if you’re under age 50, or $6,500 if you’re 50 or older.
But your contribution limit may be phased out and your ability to contribute to a Roth eliminated completely at certain higher income levels. That starts at incomes of $184,000 or more for those married filing jointly, and $117,000 or more for single filers.
If you think your income level will limit your contributions, use our Roth IRA contribution calculator.
Once you determine how much you can contribute, we suggest setting up automatic transfers to make sure it happens. There are a few perks to this strategy: Not only do you avoid the process of initiating the transfer each month, but you ensure you’re saving regularly. Many brokers also waive their initial deposit requirements if you agree to smaller automatic transfers each month. (For example: Schwab has a $1,000 account minimum, but you can skirt it by signing up for monthly auto-deposits of $100 or more.)
Just be sure you don’t contribute too much. It sounds funny, a warning against saving too much for retirement, but you don’t want to pass the contribution limit. Doing so may leave you subject to a penalty from the IRS. If your goal is to spread that $5,500 over a year, contribute $458.33 a month or $105.76 a week. If you’re 50 or older, you can contribute $541.66 a month or $125 a week.
Keep in mind, too, that the contribution limit is for all your IRA accounts combined — if you have a Roth and a traditional, that limit is a total across both accounts.
How to invest your Roth IRA
A Roth IRA is an account, not an investment. Contributing is just the first step; if you want to build wealth over time, you need to invest that money.
That involves first figuring out what kind of investor you want to be. Are you the hands-off sort? Then the aforementioned robo-advisors and target-date funds might be for you — both get you access to pretty instant diversification, though they’ll cost you a bit more in fees.
If you want to try a hands-on approach, you can get that diversification on your own for less by building a portfolio out of index funds and ETFs. To do that, you’ll want to decide how much of your money to put toward riskier investments, like stock funds, and how much you want to keep relatively safe, in bond funds and cash. This mix is called your asset allocation. In general, you’ll want to take more risk when you’re younger, because you have time to weather the market’s ups and downs. As you get closer to retirement age, you may want to tone it down a bit.
IRAs give you access to a large pool of investment options, so once you’ve decided on your allocation, you can select specific funds to meet that. Many brokers have fund screeners to help you, and you can sort by expense ratio, asset class or any number of other features.
And if you get stuck? Use a model: Check out the portfolios used by robo-advisors (often displayed on their websites) and target-date funds, then mimic them, being sure to rebalance as needed since they won’t be doing it for you.
Arielle O’Shea is a staff writer at NerdWallet, a personal finance website. Email: aoshea@nerdwallet.com. Twitter: @arioshea.
This article was updated. It originally published May 6, 2013.
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