IRAs are a powerful resource in helping you reach your retirement savings goals. While these tax-advantaged accounts may seem complicated at first, the basics are much easier to understand than you might think.
What is an IRA?
An individual retirement arrangement, or IRA, (also referred to as an individual retirement account) is a type of investment account with tax benefits that can help you save for retirement. The specific tax benefit depends on the type of IRA: Roth or traditional.
For many people, retirement planning begins and ends with their employer’s retirement plan, often a 401(k). But 35 percent of private-sector workers don’t have access to an employer-based plan, according to The Pew Charitable Trusts. That leaves many people on their own to save for retirement, and an IRA account is the perfect starting place.
The annual contribution limit for an IRA is $6,000 for 2019, and $7,000 for savers over 50 years old. These are both increases from last year’s contribution limits.
Who can open an IRA?
Anyone with an earned income – that is, income from a job that is claimed for tax purposes, not investment income or Social Security – or who has a spouse with earned income, can open and contribute to an IRA.
There are two basic types of IRAs available to individuals:
- A traditional IRA offers a tax deduction for the tax year in which the contribution was made.
- A Roth IRA gives investors the chance to invest money after taxes and then take the contributions and earnings out tax-free in retirement.
Both deductible IRAs and Roth IRAs have income thresholds that govern who can make qualified contributions to the accounts.
“If you, or your spouse, have earned income then you are eligible to contribute to an IRA,” says Greg McBride, CFA, chief financial analyst at Bankrate. “Because of the tax advantages of IRAs, the government is essentially giving you a helping hand – and a powerful incentive – to save for retirement.”
Contributions to Roth IRAs are made after taxes are paid, so there is no deduction. Instead, the contribution grows tax-free. As long as you wait until you’re 59 1/2 years old to withdraw funds, earnings will not be taxed.
How much does an IRA make per year?
The earlier you start contributing to an IRA, the more money you can potentially make. Exact amounts vary with market fluctuations, but contributing as soon as you can will give you the benefit of compound interest.
“Time is your greatest ally when saving for retirement. The longer your money is invested, the more you can harness the power of compounding,” McBride says. “A young person starting an IRA with a $1,000 investment this year could see that grow to $18,000 over the next 50 years.”
User Bankrate’s compound interest calculator to see how your investments could grow over time.
Is an IRA the same as a 401(k)?
An IRA and a 401(k) are two different types of retirement accounts. While a 401(k) plan is an employer-sponsored plan that often offers a matched contribution, and IRA can be opened by an individual.
Both accounts offer tax benefits, but a 401(k) has higher contribution limits that cap out at $19,000 per year.
Where do I get an IRA?
IRAs can be opened at most financial services providers, online or in person. That includes local banks and credit unions, brokerage firms and big mutual fund superstores or discount brokerages.
Though there are advantages and disadvantages to service providers, new savers should look for ample resources made available to investors, such as online educational materials and in-person guidance.
For example, Vanguard is one of the biggest and most popular investment firms. There is no monthly fee, but each trade costs money – and the rate increases after a certain number of trades. This encourages investors to leave their money for the long run, encouraging growth.
Casual investors looking to get their feet wet may want to try a simpler service, like Robinhood. This mobile-only investing service has a slick, user-friendly interface. Additionally, Robinhood offers no account minimums and no fees for trades – two alluring features for who aren’t completely comfortable in the market yet.
Need more help? Check out Bankrate’s brokerage reviews to help determine which is best for you.
Questions to ask providers:
- What are the fees for the account?
- What kind of guidance or advice is available? How much does it cost? How are advisers paid?
- What types of investments can be held in the account?
- What are the trading costs?
Is an IRA a good investment?
Every investment comes with risk. Considering investing for retirement is a long-term plan, using a retirement account like an IRA is generally a wide choice.
Ideally, people with a long time until retirement will invest in the stock market. Investors with 10 or more years until retirement can afford to take on more risk and go for the high returns offered by the stock market rather than playing it safe with certificates of deposit and Treasury bonds; you can’t lose money in very safe investments, but you can’t earn much either.
The easiest solution to the investing dilemma? Go with a total market index fund to get started.
A total market index fund offers instant diversity, which mitigates many of the risks inherent in the market such as specific company risk or geographic risk. Those risks arise when just one or two companies — or even just one country — account for most of a portfolio.
Consistent saving coupled with a reasonable rate of return over a long period of time will help you reach your retirement savings goals.