An IRA, or Individual Retirement Account represents a great way to supercharge retirement savings for self-employed individuals without an employer-sponsored 401K. The tax-exempt savings account with an option to invest across a wide range of financial products, including equities, debt, ETFs, mutual funds, and commodities remain as popular as ever, despite the restrictions and limitations they come with.
With the right planning, approach, and execution, IRAs can be significant wealth creators for middle-class professionals and families across the world. While there are limits to how much you can contribute, when you can withdraw, and how the funds can be managed, you can get a brief understanding of everything with help of SoFi’s IRA contribution calculator for free.
Opening an IRA has also been made incredibly simple, with numerous banks, brokerages, and robo-advisors helping investors get started effortlessly. With a few essential considerations, simple documentation, and a seamless process that is almost entirely online, you can be good to go within just a few short hours.
Decide Between A Traditional & Roth IRA
To start with, investors need to understand the two primary types of individual retirement accounts, the traditional IRAs, and Roth IRAs.
They differ mostly in how contributions are taxed, and in simple terms, with traditional IRAs you contribute pre-taxed dollars, the gains and returns are accrued on a tax deferred basis, whereas the withdrawals are taxed as current income at the time of retirement. Whereas with a Roth IRA, contributions are based on after-tax income, and any gains and withdrawals are tax-free at retirement.
The right choice for each individual depends on their current taxable income, and what tax bracket they expect to be in at the time of retirement. If you expect to be in the highest tax bracket when you turn 60, it makes sense to with a Roth IRA, similarly if you’d like to avoid the high taxes you are paying now, a traditional IRA would be more suitable.
Decide Where To Open An IRA
As mentioned earlier, investors are spoilt for choice when it comes to the number of avenues for opening, and managing their IRAs, which also means there is a lot of thought, and research required before narrowing down to the ideal choice.
While most IRA providers offer a similar range of investment products, and features, the differences lie in their fee structures. There are a number of fees, starting with account management fees, transaction fees, and commissions, among other things, which altogether constitutes the expense ratio.
These fees might seem immaterial for most people, ranging from just 0.1% to 0.5%, but as your corpus grows, and the years pile-on, minor variances in the fees can make a substantial difference to the overall performance of your investments over the decades.
Ideally, large diversified financial institutions, with a basket of no-load mutual funds such as Fidelity, and Vanguard are preferred options, with low-cost, and efficient operations across the board. Such companies also bring forward decades of institutional experience, making them all the more safer.
Select An Investment Approach
Given the wide range of options available for IRA investors, and the substantially longer time horizon than most other investments, a longer-term, buy and hold approach works best.
While young professionals can afford to take risks early on in their careers, recent data points to better performance net of fees when money is just parked in an index ETF. Ideally, a balanced fund with a diverse allocation works best across all market conditions and time horizons and is offered by most leading investment managers like Fidelity, Blackrock, and others.
Investors looking for a more hands-on approach can also consider Self-Directed IRAs (SDIRA), where the fund is managed by the owner, while still administered by a custodian. With SDIRAs, investors can choose from a wide range of alternative investment opportunities such as real estate, that are prohibited with other IRAs. In fact, you can even deploy your IRA funds into Bitcoin with the help of a custodian to accommodate the same.
Open An Account & Fund It
While the exact process of opening an IRA varies by provider, setting up an individual retirement account is easy. You can go to the provider’s website and select the type of IRA you want to sign up for before filling out some details about yourself and your profession.
Next, you can choose how you would prefer to fund your IRA account. This is generally done through bank transfer, transfer of existing IRA assets, or roll-over of a 401(k). It is important to remember that you can contribute up to $6000 in IRAs in 2022. You should also check the income limits for IRAs before investing.
Individual Retirement Accounts represent a great option for middle-class professionals to save on tax, while growing their retirement corpus.
While the system offers extensive flexibility when it comes to trading and asset allocation, withdrawal remains restricted, and involves a penalty if any of the amount is withdrawn before the account holder turns 59 and a half years old.