The Top IRA’s For You
If you’re somewhat new to investing and retirement planning, it can be hard to figure out the right IRA account for you. Whether you’re using a financial advisor, robo-advisors, or going solo, you might start comparing options by looking at each contender’s annual fee, commission rates, and customer service.
Here’s an overview of IRAs and why each might be right or wrong for you.
These are the topics we will cover:
- IRA accounts: Powerful retirement savings tools
- Types of IRA accounts
- How to find the best IRA accounts
- How to make the most of your IRA accounts
IRA accounts: Powerful retirement savings tools
An IRA is a tax-advantaged retirement account that most people can set up on their own and contribute to regularly, saving money for retirement. 401(k) accounts are also good, but they require an employer sponsor. One of the costliest mistakes you can make regarding IRAs is to underestimate their power and how much they can strengthen your financial security in retirement. One way or another, the different kinds of IRAs offer some tax benefit — and permit you to amass a sizable nest egg.
The table below shows how much money you can accumulate with annual contributions of only $5,000, growing at different average annual rates:
|Growing for||Growing at 8%||Growing at 10%||Growing at 12%|
|30 years||$611,729||$904,717||$1.35 million|
DATA SOURCE: CALCULATIONS BY AUTHOR.
It’s rather amazing, no? With enough time, annual contributions of just $5,000, and the magic of compounded growth, you might accumulate well over $1 million! There’s a good chance you can sock away more than $5,000 annually, too — and you can also be saving in non-IRA accounts, such as a 401(k) through your employer or a regular, taxable brokerage account.
It’s clearly smart to figure out which IRA accounts are best for you, so that you can start (or continue) saving and investing.
Types of IRA accounts
There are a handful of major types of IRA accounts, which are as follows:
- Traditional IRA accounts
- Roth IRA accounts
- SEP-IRA accounts
- SIMPLE IRA accounts
- Spousal IRA accounts
- Non-deductible IRA accounts
- Self-directed IRA accounts
- Rollover IRA accounts
- Backdoor Roth IRA accounts (converting a traditional IRA to a Roth IRA)
- Inherited IRA accounts
The two main kinds that many people know about are traditional IRAs and Roth IRAs. But there are others — for the self-employed, those with little to no income, and others. Here’s a quick look at a few kinds of IRAs.
Traditional IRA accounts
With a traditional IRA, you contribute pre-tax dollars, reducing your taxable income for the year, and thereby decreasing your taxes, too. So, in a simplified example, if your taxable income is $75,000 and you contribute $5,000 to your traditional IRA, your taxable income for the year will drop to $70,000, shrinking your tax bill for the year of the contribution. The money grows in your account and is taxed only when you make withdrawals. Those sums are taxed at your ordinary income tax rate, which at the moment might be anywhere from 10% to 37%.
The contribution limit for traditional and Roth IRAs is $6,000 for the 2019 tax year, with an additional $1,000 “catch-up” contribution allowed for those 50 and older. The contribution limits change over time, though not necessarily every year. The limits are also total ones, for contributions made to one or more traditional and/or Roth IRAs. So, if you’re 52, you could sock $6,000 into a single IRA or you could distribute that sum across multiple IRA accounts.
Here are some other key things to know:
IRAs (either type) can only be funded with earned income. If you haven’t earned any income in a given year and you received a gift of, say, $5,000, you can’t plow it into an IRA. Also, though most of us with earned income are eligible to contribute to IRAs and deduct contributions to traditional IRAs, there are a few exceptions. For example, those with high incomes can face limits or be ineligible.
Finally, know that traditional IRAs, like traditional 401(k)s, feature required minimum distributions (RMDs) that must be taken annually once you become a septuagenarian. The deadline to take your distribution each year is Dec. 30, except for the year in which you turn 70 1/2. For that year, you have until April 1 of the following year to take your RMD. (It can be better to take it before the end of December regardless, though, lest you end up taxed on two distributions in one year, which might push you into a higher tax bracket.) Fail to follow the RMD rules and you can owe the IRS a whopping 50% of the amount you didn’t withdraw on time. So, if you were supposed to withdraw $7,000, you’re looking at forfeiting $3,500! (The IRS does let you appeal for a waiver, though.)
Traditional IRAs can be particularly good for you if you’re in a high tax bracket now and expect to be in a lower one in retirement. In that case, you can avoid paying taxes at the high rate on a chunk of your income now, and pay taxes later, at the lower rate.
Roth IRA accounts
While a traditional IRA offers a tax break up front, when you contribute to it, a Roth IRA offers a back-end tax break: You contribute post-tax dollars to it, and if you’ve followed the rules (such as having contributed to the account for the first time at least five years ago), when you withdraw money from the Roth IRA in retirement, those withdrawals will be tax-free!
To appreciate how powerful that can be, revisit the table above, showing how much money you might amass over various periods at various growth rates simply by investing $5,000 per year. If you did so for 25 years and had an average annual growth rate of 8%, you’d end up with almost $400,000 — and it would all be yours for the taking in retirement — tax-free.
Most of us can contribute to Roth IRAs, but if you’re a high earner, you may face income limits for contributions, reducing how much you can contribute or disallowing any contributions. Single tax filers or heads of households start being restricted when their income hits $122,000 (for 2019), while taxpayers who are married filing jointly start being restricted at $193,000 of income.
Traditional or Roth IRAs are the best options for most of us. You can even have one or more of each variety — you don’t have to choose only one.
If you’re a small business owner or are self-employed, you probably have no 401(k) account for yourself or your employees. That’s a shame, because 401(k)s offer much higher contribution limits than traditional and Roth IRAs. Fortunately, you may take advantage of SEP-IRAs. (The term SEP-IRA is short for Simplified Employee Pension IRA.) For 2019, the contribution limit for SEP-IRAs is 25% of your net income, up to $56,000. Thus, if you earn, say, $80,000 in 2019, you may be able to sock away $20,000 in a SEP-IRA account. (It can be a little tricky figuring out exactly how much you can contribute, so using tax prep software or a tax pro is a good idea.) You can set up a SEP-IRA at most major brokerages.
SIMPLE IRA accounts
Another option for self-employed folks is the SIMPLE IRA, originally known as the Savings Incentive Match Plan for Employees. In the words of the IRS itself, this option “allows employees and employers to contribute to traditional IRAs set up for employees. It is ideally suited as a start-up retirement savings plan for small employers not currently sponsoring a retirement plan.”
A SIMPLE IRA is a lot like a traditional IRA, but with higher contribution limits — which, for 2019, allow workers to contribute up to 100% of their income, up to $13,000 ($16,000 for those 50 and older). Employers are required to make a matching contribution of up to 3% or to contribute 2% of each eligible worker’s compensation. There are some other rules to know, too, such as this one: After two years, you can roll over a SIMPLE IRA into a traditional IRA.
Spousal IRA accounts
Remember that you can only contribute earned income to an IRA? That can be a bummer if you’re a stay-at-home spouse, or are simply a spouse with little to no income of your own. Fortunately, there’s an IRA for you — the spousal IRA. (Note that unmarried folks with little to no income are out of luck here — this IRA is only available to married people.)
With a spousal IRA, if the two of you file a joint tax return, you can both contribute to IRAs of your own — traditional and/or Roth. The total amount contributed can’t be more than your total earned income, though, and the owner of the spousal IRA can’t be contributing to it if he or she is age 70 1/2 or older.
The contribution limit for the spousal IRA is the same as for traditional and Roth IRAs — $6,000 in 2019, plus an additional $1,000 for those 50 and older. This limit is in addition to the limit for the working spouse’s IRA(s). So, if you’re both, say, 60 years old, each one of you can contribute up to $7,000 to your traditional and/or Roth IRA(s).
Nondeductible IRA accounts
Here’s another kind of IRA that’s very much like a traditional IRA: The nondeductible IRA. Remember that with traditional IRAs, most people can deduct all of their contribution each year when preparing their tax return. Higher earners, though, face income limits and may be able to contribute only some or none of what they contribute.
To get around that a little, you might contribute to a non-deductible IRA for yourself. Like a Roth IRA, it accepts post-tax dollars — a chunk of your taxed income. Once in the account, those dollars can grow, invested, for many years, on a tax-deferred basis. So, every time you buy or sell a security in the account, you won’t be calculating your capital gain or loss and entering it in your annual tax return.
Come time to start withdrawing money in retirement, you will face taxation, but only on any gains you’ve accumulated in the account. In a simplified example, if you contributed a total of $100,000 and the account is now worth $225,000, you’ll only be taxed on the $125,000 of gain. The other $100,000 had already been taxed before you contributed it to the account.
This kind of account might serve you well if you have a high income and can’t otherwise contribute to a Roth IRA or take deductions for contributions to a traditional IRA.
Self-directed IRA accounts
The self-directed IRA is for those who want to be able to invest their IRA dollars beyond the typical options of stocks, bonds, exchange-traded funds (ETFs), and mutual funds. A self-directed IRA can take the form of either a traditional IRA or a Roth IRA — with the same contribution limits, eligibility criteria, and other rules.
So what exactly might you invest in via a self-directed IRA — besides stocks, bonds, ETFs, and mutual funds? In a self-directed IRA, you can invest in the usual things, such as stocks, bonds, ETFs, and mutual funds. But you can also invest in real estate, though only investment property, not a property you will live in. You can invest in gold, silver, or other precious metals, too — and even bitcoin and other cryptocurrencies. Various forms of debt are also allowed, such as buying loans or interest in loans. You can buy into privately owned businesses (as opposed to public, traded-on-the-stock market businesses), too. Not everything is allowed, though — you can’t invest in, say, life insurance, baseball cards, antiques, rugs, gems, coins, or stamps.
Just know that some of those options are allowed as self-directed IRA investments only if you follow a bunch of rules. Fail to do so and you can lose the tax benefits that you were seeking in the first place. Do your homework before going down this road, and know that you might do best simply sticking with a regular, old-fashioned IRA or two.
Rollover IRA accounts
A rollover IRA is what you need to set up if you want to transfer assets from a retirement plan such as a 401(k) into an IRA. That happens most often when you leave a job. At that time, many people unwisely cash out their 401(k)s, but that’s usually a bad idea, short-changing their retirements. Instead, if you follow the rules, you can simply transform your 401(k) into a traditional or Roth IRA, where the assets can continue growing for you on a tax-advantaged basis.
An added benefit of rolling over a 401(k) to an IRA is that you’ll be able to enjoy more investment options. 401(k) plans often feature just a few or a dozen or so different investment options, such as mutual funds, and don’t usually permit you to invest in stock in individual companies, except perhaps the stock of your employer. But with an IRA, you can invest in just about any stock or bond, and you can often choose from among hundreds of mutual funds, depending on your brokerage.
Backdoor Roth IRA accounts (converting a traditional IRA to a Roth IRA)
If you love the key advantage of a Roth IRA — tax-free withdrawals in retirement — but you’re not able to contribute to a Roth IRA because you earn too much, there’s a trick you might employ: You can contribute to a traditional IRA and then convert it to a Roth IRA. That’s referred to by some as a “backdoor Roth IRA.”
That may sound terrific, but it’s not the best move for everyone. For starters, it will cost you. The money in your traditional IRA that was contributed on a pre-tax basis (reducing your tax hit for the year of the contribution), along with its earnings in the account, will have to be taxed in the year of conversion. That can be a big deal, if you’re converting a traditional IRA with a lot in it. If the account is worth, say, $100,000, you might end up paying around 24% in tax on it — a whopping $24,000. That would leave your new Roth IRA with around $76,000 in it. (Of course, that money will then be able to grow for more years and will not be taxed at all upon withdrawal, if you follow the rules.
Converting to a Roth IRA can be especially smart if you expect to be in a higher tax bracket in retirement than you are now. But if you’re earning a lot more now than you think you’ll earn in retirement, you’re likely to be in a lower tax bracket in retirement and you might prefer to avoid the higher tax rate now, with the traditional IRA.
Read up on this option if you’re interested in it, because there are some complicated Roth conversion rules that might apply.
Inherited IRA accounts
Another kind of IRA you might have is one that you never established in the first place — but one you simply inherited. If you’re fortunate enough to get an inherited IRA, you should read up on the inherited IRA rules governing it in order to deal with it in the best way for you. Much will depend on whether you’re the surviving spouse of the IRA’s original owner and your age. You can opt to take all the money out at once, in a lump sum, or to take it in chunks. If you choose to take the money out gradually over the course of your lifetime, you’ll have a “stretch IRA” on your hands and will need to take required minimum distributions (RMDs) according to a schedule.
How to find the right IRA accounts for you
All the information above can help you figure out which kinds of IRAs will serve you best. With that knowledge under your belt, you may next need to actually open an IRA account or two.
Many financial services companies, such as brokerages, banks, and mutual fund companies, offer IRAs. You might prefer a particular company for any of a number of reasons. If you do a lot of business with one company and like it, you might want to stick with it. Having different accounts at one institution can make it extra easy to move money between accounts when you want to — such as if you want to fund your IRA with money from a brokerage or bank account.
At The Ascent (a Motley Fool company focusing on personal finance) you can access a handy table featuring a handful of solid IRA providers. Here are a few companies that offer IRA accounts that would serve most investors well, especially those who favor low trading commissions:
|Broker||Stock Trading Commissions|
|TD Ameritrade||As low as $7 per trade|
|Fidelity Investments||As low as $5 per trade|
|Merrill Edge||As low as $7 per trade|
|E*Trade||As low as $5 per trade|
|Ally Invest||As low as $5 per trade|
|Charles Schwab||As low as $5 per trade|
|Vanguard||Usually $7 per trade|
DATA SOURCE: THEASCENT.COM.
Once you open an IRA account — which you can often do online — you’ll just need to fund it. That can be done online, sometimes by phoning in payment information, or by mailing in a check. Next, you’ll want invest your hard-earned dollars as effectively as you can.
How to make the most of your IRA accounts
For best results when saving for retirement with an IRA, contribute as much as you can — and as soon as you can. The longer your money has to grow, the more it can grow.
How should you invest those IRA dollars? Well, for most of us, a simple, low-fee index fund or a few of them can be all we need. The SPDR S&P 500 ETF (SPY), Vanguard Total Stock Market ETF (VTI), and/or Vanguard Total World Stock ETF (VT) or low-fee funds like them are great candidates. Respectively, they’ll spread your money across 80% of the U.S. market, the entire U.S. market, or just about all of the world’s stock market. There are lots more index funds to choose from, including ones for bonds, such as the Vanguard Intermediate-Term Bond ETF (BIV) or the Schwab U.S. Aggregate Bond ETF (SCHZ).
To make your retirement as financially secure as possible, look into setting up one or more IRAs and contributing to them regularly and generously.