Update: The deadline for making IRA contributions for tax year 2020 has been extended to May 17, 2021.
Saving for retirement may be the biggest financial goal many of us will ever set. So it makes sense to explore all retirement savings options, including an IRA. The sooner you open your first IRA, the more opportunity your savings have to grow over time, potentially leading to a nice nest egg upon retirement.
There are other benefits to opening an IRA. It can deliver attractive tax perks—either up front or in retirement—and can be especially attractive to individuals who don’t have an employer-sponsored 401(k), or have maxed it out already.
This article will walk you through the steps of opening an IRA—whether a traditional, Roth, or SEP IRA.
An IRA, or individual retirement account, is a retirement savings account that anyone with an income can open on their own (rather than through an employer, as with a 401(k)). This account can potentially grow funds through investment, and typically offers tax breaks, either up front, or upon withdrawal in retirement.
When people ask “what is an IRA” they might be wondering what types of IRA there are to choose from. There are three basic types of individual retirement accounts: a traditional IRA, a Roth IRA, and a SEP (Simplified Employee Pension) IRA. (There is also a SIMPLE IRA, for small business owners and their employees.)
How to Open an IRA in 4 Steps
Step 1: Choose the IRA That’s Best for You
Of the several types of IRAs, traditional and Roth IRAs are the most common types. Both allow you to put a certain amount toward retirement each year and invest in an array of assets. When it comes to choosing a traditional IRA vs. Roth IRA, it helps to be aware of their key differences.
Traditional IRA Accounts
If you earn a taxable income, you can open a traditional IRA regardless of how much you make per year.
One notable difference between traditional and Roth IRA accounts is that traditional IRAs allow you to deduct your contributions on your tax returns now, meaning you pay taxes on distributions when you retire.
You’ll also pay a 10% penalty tax (in addition to regular income tax) on any money you withdraw money from your traditional IRA before age 59 1/2, with a few exceptions.
It may be better to go with a traditional IRA if you pay a lot in taxes now and think you’ll be in a lower tax bracket after retirement. This is because you’ll be saving on a higher tax you’d be paying earlier (vs. the lower tax you’d be paying later, since you’d be in a lower tax bracket).
Roth IRA Accounts
Unlike traditional IRAs, there are income limits on who can open a Roth IRA. For 2021, individuals can only contribute the full amount—$6,000, with an additional $1,000 for people over age 50—to a Roth IRA if their income is below $125,000 for single people (people earning more than $125,000 but less than $140,000 can contribute a reduced amount); for married people who file taxes jointly, the limit is $198,000 (those who earn up to $208,000 can contribute a reduced amount).
Roth IRA contributions are made with after-tax income. While that doesn’t offer any tax advantages now, it does mean that when you withdraw money upon retirement, you won’t have to pay taxes on it.
While IRAs are intended to serve as retirement savings, it’s typically easier to withdraw contributions in an emergency from a Roth IRA than from a traditional IRA. While contributions won’t be taxed upon withdrawal, any withdrawn earnings would be taxed and possibly subject to a 10% penalty.
A Roth IRA may make sense for eligible individuals who typically get a tax refund and expect to be in a similar or higher tax bracket when they retire (for example, if they plan to have substantial income from a business, investments, or work).
Still confused? Consult our IRA Calculator for help deciding which account may be right for you.
Related Content: How IRAs Work
SEP IRA Accounts
With the number of self-employed workers on the rise, it’s worth mentioning that there’s a third type of IRA that may be worth considering: a SEP IRA. A SEP IRA, or simplified employee pension, can be set up by either an employer at a small business or by someone who is self-employed.
For employers, it gives them a tax deduction when they contribute to their employees’ IRAs, and also lets them contribute on a “discretionary basis” (meaning that the employer doesn’t have to contribute in years where it’s not as financially feasible for the company.) This option may also allow you to contribute more than other IRAs, depending on your income.
Step 2: Open an Account
You can open an IRA at a bank, a brokerage, mutual fund company, or other financial services provider. Typically, the more personal care and advice you get, the higher the fees will be. A robo-adviser, for instance, might charge lower fees than a brokerage.
SoFi Invest® streamlines the process of opening an IRA online, allowing investors to transfer money from their bank electronically.
Rolling Over a 401(k) Into an IRA
If you are leaving a job with an employee-sponsored retirement plan, you can roll over your 401(k) into a traditional IRA to potentially give yourself better investment options and lower fees.
When you roll money over from a 401(k), there’s no limit to how much you can add to an IRA at that time. Going forward, additional contributions will be capped at the typical IRA contribution limit.
Step 3: Make Contributions
As of 2021, you can contribute up to $6,000 a year to a traditional or Roth IRA, or up to $7,000 if you’re 50 or older. If you take home more than the maximum earnings allowed for a Roth IRA but still prefer a Roth over a traditional account, you might be able to contribute a reduced amount.
In many cases, it’s a good idea to invest as much as you can up to that amount each year to take full advantage of the power of compound interest.
A retirement calculator can help you figure out whether you’re on track for retirement. A quick rule of thumb: By the time you’re 30, it’s typically good to have the equivalent of one year’s salary saved.
Step 4: Invest Your Funds
Investors can choose to invest in stocks, bonds, mutual funds, low-cost index funds, or exchange-traded funds (ETFs)—or a combination thereof.
One popular type of investment fund geared toward retirement savings is a “target date fund.” A target date fund is calibrated to the year you plan to retire, and is meant to automatically update your mix of assets like stocks and bonds so they’re more aggressive earlier in life and more conservative as you approach retirement.
Ultimately, the mix of investments in your IRA should depend on your personal risk tolerance, lifestyle, and retirement goals.
Opening your first IRA is simple—possibly the biggest work involved is in deciding which IRA suits your personal situation and retirement goals best: a traditional, Roth, or SEP IRA.
Getting started on saving for your retirement doesn’t have to be difficult. SoFi Invest makes opening an IRA simple. Sign up for an investment account with SoFi online, in less than five minutes.
You can be as involved in the investment process as you want to be—either with hands-on investing, or by using our automated investing technology, in which our algorithm will suggest an appropriate mix of investments based on your age and retirement goals. For a limited time, opening an account gives you the opportunity to win up to $1,000 in the stock of your choice. All you have to do is sign up, play the claw game, and find out how much you won.
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