If you’re considering opening your first IRA, or Individual Retirement Account, good for you! After all, saving for your retirement may be the biggest financial goal you’ll ever set.
And although with a traditional IRA you can’t contribute past age 70 ½, with a Roth IRA there’s no cut off. Either way, you likely have ample time to open an IRA, getting you moving towards that big financial goal.
An IRA lets you invest your savings so that your money will hopefully grow over time into a healthy nest egg.
Plus, it can deliver attractive tax perks and offers you an opportunity to save for retirement, especially if you don’t have an employer-sponsored 401(k) or have maxed it out already. So what are you waiting for?
Opening your first IRA can be a bit like waking up early or eating eight servings of vegetables per day. Even though it could be a smart thing to do, you’re intimidated because it seems really hard—but once you get started, it may not be so scary.
Doing the responsible thing doesn’t have to be difficult. Here’s a step-by-step guide for help in getting into the IRA game.
Steps to Opening an IRA
Step 1: Choosing the IRA That’s Best for You
There are several types of IRAs, with traditional and Roth IRAs as the most common types. Both allow you to put a certain amount toward retirement each year and invest in an array of assets. They differ in several key ways.
Roth IRA Accounts
First, you can only contribute to a Roth IRA if your income falls below a certain amount. For 2019 & 2020, you can contribute up to $6,000 per year if you’re single and your modified adjusted gross income, or AGI, is under $122,000. For age 50 and older you can contribute an additional $1,000.
If you’re married and filing jointly, your AGI can be up to $196,000 in 2020. If you earn more than the designated amount, you can either contribute less money or look into opening a traditional IRA instead.
Second, the type of IRA will affect your tax situation. With a Roth IRA, your contributions are made with after tax income sowhen you withdraw money upon retirement, you don’t have to pay taxes again.
Third, you can contribute money to your Roth IRA at any age. This means that if you are, say, 85 and still earning income, you can still contribute a portion to your retirement account.
Finally, it’s usually easier to withdraw contributions from a Roth IRA than a traditional IRA without being penalized. Yes, there are rules, but they’re not as strict as the regulations for traditional accounts.
If you’re eligible, you may want to go with a Roth IRA if you typically get a tax refund and expect to be in a similar or higher tax bracket when you retire (for example, if you plan to have substantial income from a business, investments, or work). It is recommended that you consult a tax professional to help work through the numbers.
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Traditional IRA Accounts
If you earn a taxable income, you can open a traditional IRA regardless of how much you make per year.
The most notable difference between traditional and Roth IRA accounts is probably that traditional IRAs allow you to deduct your contributions on your tax returns now, meaning you pay taxes on distributions when you retire.
There are a couple other important differences, too. While you can theoretically contribute to a Roth IRA for your entire lifetime, you must stop putting money in your traditional IRA at age 70 1/2.
You’ll also pay a 10% penalty tax if you withdraw money from your traditional IRA before age 59 1/2, with a few exceptions.
It’s often 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 than in the year they were made. 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).
Still confused? Consult our IRA Calculator for help deciding which account may be right for you.
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 you can consider: 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.
Again, there are several kinds of IRAs, so it’s possible a type other than these three might be the right fit for you.
Step 2: Opening an Account
You can open an IRA at a brokerage, mutual fund company, or other financial services provider, including SoFi Invest®, which makes it easy to open an IRA online and transfer money from your bank electronically.
If you are leaving a job with an employee-sponsored retirement plan, you can roll over your 401(k) into an Traditional IRA to potentially give yourself better investment options and lower fees.
However, it’s important to note that while you can rollover your 401(k) into a traditional IRA and not have to pay taxes on it upfront.
Step 3: Making Contributions
As of 2020, 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 traditional account, you might be able to contribute a reduced amount.
Check out the IRS’s Roth IRA webpage to determine how much you can contribute. In most cases, you may want to throw in 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. A quick rule of thumb that many financial advisors use: By the time you’re 30, it’s typically good to have the equivalent of one year’s salary saved.
If you’re rolling money over from a 401(k), there’s no limit to how much you can add to an IRA at that time as this process is simply adding money from your current 401k into an IRA account.
Note that you can withdraw cash without paying taxes or penalties in certain situations (for instance, you can withdraw up to $10,000 when purchasing your first home), but you may not want to treat your retirement account like a piggy bank, because there are limits.
Step 4: Investing Your Funds
If retirement is still a long way out, you may not want to let your money sit around in cash. Because of inflation, letting your money sit around in cash form (even with an interest-bearing savings account) may mean a decrease in its purchasing power over time—making it less likely for you to reach your purchasing goals.
Instead, you may want to consider investing it in a range of well-diversified index funds. Though index funds, like all investing, carries risk of loss, over time they may provide you with potentially better returns.
One possible way to invest is to choose a “target date fund.” This is a type of mutual fund, or a program that combines assets like stocks and bonds. A target date fund is geared toward the year you plan to retire, and will automatically update your mix of investments so they’re more aggressive earlier in life and more conservative as you approach retirement.
Setting up a target date fund is only one way to invest through your IRA. You could also invest in other types of mutual funds, or in individual stocks, low-cost index funds, or exchange-traded funds.
Some people prefer to tackle investing on their own, while others prefer to turn to professionals for help.
Taking the Next Step Now
Getting started on saving for your retirement doesn’t have to be difficult. SoFi Invest® makes opening an IRA easy. Sign up for an investment account with SoFi online, in less than five minutes.
Our technology can help you pick an appropriate mix of investments based on your age and retirement goals, and you can be as involved in the investment process as you want to be.
Going through a human professional or robo-advisor often may involve extra expenses, but SoFi doesn’t assess any management or transaction fees.
And if you have any questions or want personalized advice, you can set up a call with a SoFi financial planner—absolutely complimentary.
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