Choosing the Right IRA

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There are lots and lots and lots of ways to invest. Even when talking about one specific investment category, such as small businesses or real estate, there are a dozen different ways you can put your money to work in that market. With that in mind, this post will dive into a larger investing tactic that encompasses a variety of other investing options. Today we answer the question, what is an IRA?

These savings/investing accounts aren’t the only way to grow your retirement funds, but they do enable people to put money away regularly and build up an income to live off once your working days are done. If you open an account early enough, you’ll see your wealth grow substantially before it’s time to retire. I encourage you to invest your money in other ways as well, but this is a smart choice for anyone who doesn’t have a lot of time to think about their investment strategy.

To get the most out of your IRA, you need to have an understanding of how these accounts work and what your best option is. I think self-directed IRAs are the cream of the crop, but also believe any IRA is better than no retirement account; you also have to decide whether a Roth or traditional IRA is the right choice for your future planning. I’ll get into all of that in a bit. For now, let’s start at the beginning.

What Is an IRA?

As is the case with so many common acronyms, vast numbers of people have never bothered to think about what these letters stand for. Individual retirement account is the answer. It’s a pretty simple concept and, if you started reading with zero idea of what an IRA is, you’re already about three words smarter!

On a very basic level, this is how you save for retirement if you don’t have a pension or a 401(k) through your work. Pension plans are rare these days, and 401(k)s aren’t all they’re cracked up to be, making this type of individual account the best option for most people. As long as you invest through an honest broker, your IRA shouldn’t include too many fees and it won’t spread your wealth around between too many companies.

In contrast to an employee-sponsored retirement account, a personal plan offers more control and usually limits your exposure to excessive service fees. As I said in the beginning, I’m a big proponent of self-directed IRAs, which aren’t the most common choice. A self-directed IRA allows you to invest in assets beyond the usual stocks and bonds. This means you can diversify more fully, invest more tangibly, and still capitalize on the tax benefits that make IRAs so popular. Managing a self-directed account becomes somewhat more involved, which is why a lot of companies don’t have this option in the books. If you don’t have a self-directed IRA, it’s not the end of the world, but I do encourage you to look into this option.

With all IRA accounts, the maximum annual contribution is $5,500 if you’re under 50 and $6,500 if you’re 50+. After you turn 70½, you don’t get to contribute any more money and you have to start taking an annual withdrawal. Just like with a 401(k), you get dinged for trying to access the money in a traditional IRA before you turn 59½. With a Roth, you have penalty-free access to your contributions, but can’t touch the earnings in your account without incurring a 10 percent fee. This is one of my major peeves with retirement accounts, though it is a safeguard to keep people with poor money management skills from blowing through their retirement savings during a midlife crisis.

While other investments might offer bigger returns, you need to have an account that will keep growing until you stop working. It’s beyond important that you save for retirement, and IRAs help people ease some of their fears about the markets and get their money invested. You also get to dictate how big a role you play in your retirement account, which is a good way to become more knowledgeable about investing and make the most out of your other financial endeavors.  

Roth vs. Traditional IRA

When you first open your retirement account, you face one big decision: traditional or Roth? Frustratingly, neither of those words mean anything to most people.

This distinction has very little to do with how your money gets invested, but rather with how your dollars get taxed. With a traditional IRA, you put your money away before taxes and then have to pay the IRS piper when you withdraw. Roth IRAs draw taxes before investing the funds, which allows you to pocket that money tax-free in your 70s. If you’re waiting for me to tell you which option is right for you, you’re going to be waiting a long time.

Both options have benefits, but it’s hard to know exactly how those benefits will play out until you’re retired. If you know for certain that you’ll step into a lower tax bracket when you stop working, you’ll be better off with a traditional IRA. If you plan to have gobs of money saved up and lots of different assets when you retire, you’d be better off paying those taxes now. Unless you’ve got a knack for predicting the future, it’s hard to guarantee you’re picking the right account.

There’s definitely something to be said for paying your taxes upfront so you don’t have to factor in that loss when you start making withdrawals. A Roth IRA offers you the assurance you can skip tax payments in your later years. This will be especially important if personal income tax rates have gone up significantly between now and when you retire. However, if rates drop for whatever reason, you’ll be wishing you had a traditional IRA full of untaxed money.

When discussing these accounts, it’s important to remember that an IRA isn’t an investment in and of itself; these accounts serve as the vehicle for your retirement investments, and you get to fill them with stocks and bonds and all sorts of other goodies. That’s why the company you choose to manage your account is so important. Aside from just making sure you’re working with an honest broker, different companies prefer to invest in different types of assets. Don’t lose sight of that when thinking about which type of IRA you should choose.  

Picking between traditional and Roth IRAs is just the first step of establishing your retirement account. Next up will be figuring out how much you can put into this fund and what platform you should use. You need to put some thought into these matters, as your future depends on the choices you make.

The Where and the What of Your IRA

Walk downtown, throw a stone, and you’ll probably hit a business that manages IRAs. This is both the good and bad news with these accounts - they’re easy to establish, but so easy that a lot of people end up with a so-so product.

Since you can open an IRA almost anywhere, you need to start by narrowing down the options and deciding which you prefer.

1. Traditional Banks and Lenders

For the investor who doesn’t love the idea of all money matters being handled digitally, your local bank is as good a place as any to open a retirement account. You can do this at small banks and huge corporations, and you should be able to open both Roth and traditional (and hopefully self-directed) IRAs.

Bank investing has pros and cons. On the plus side, you should have access to a variety of investment options within your IRA. One of the major cons is that smaller, full-service banks often become overextended and can’t always keep up on the latest investment options and tactics; this can lead to a one-size-fits-all style of account management, and that almost never works. Of course, this isn’t always the case. If you go with a standard bank, make sure to ask questions about how IRAs are managed, what the fees are, etc.

2. Online Brokers and Robo-Advisors

If you’ve accepted that modern life is a virtual phenomenon, an online broker or a robo-advisor makes for a good option. The big brokerage companies like E*TRADE and TD Ameritrade are common choices that have plenty of options for your IRA, assuming you know what to ask for. The danger with choosing such a big company is getting lost in the shuffle, as you’ll be one of millions of clients and you can’t expect to get too much personal attention.

Robo-advisors aren’t all that different, just a little more specialized. Betterment has my endorsement as an online investment company, as the advisors work to serve their clients’ best interests and don’t have other authorities dictating what gets bought or sold. This is a great option if you’re rolling over a 401(k) or an IRA that hasn’t been properly managed.

If you go with an online company, whether it’s a standard broker or a robo-advisor, you should still educate yourself on IRAs before investing. These services make it really easy to get started, but the more you know before diving in, the more success you’ll have.

3. Alternative Options

Like I said, you can get an IRA almost anywhere. I’ve previously mentioned LendingClub in other posts, which is a peer-to-peer lending platform, serving both borrowers and investors. This company also offers an IRA, providing the aforementioned tax benefits while spreading your vested funds through various types of loans and Notes. You get to determine your retirement and investment strategy, as well as choosing what type of IRA you want, and then LendingClub manages the account.

This is in line with the self-directed IRA strategy. As opposed to filling your portfolio with lousy mutual funds and underperforming bonds, you can put your dollars to work in more effective ways. When you explore alternatives to the stock market, your retirement account can grow through real estate, business loans, commodities and a variety of assets. Instead of over-diversifying with a bunch of ETFs, spread your wealth appropriately through selective investment types. This is how you can make the most of your IRA.

The Long Haul

When you open an IRA, you declare your interest in living a fruitful life into your later years. If you refuse to start a retirement account, or you take the penalty and withdraw retirement funds early, you’re kind of suggesting you don’t really care about your future self. Dramatic as that may sound, it’s a little bit true.

Because you’re choosing to put money away that you won’t touch for 10 or 20 or 30 or (hopefully) 40 years, you need to be smart about how that money is invested. While you always have the option to roll an IRA or a 401(k) over into a different account, you’ll be happier and your money will get more work done if it gets to stay put. Depending on who you’re transferring from and where you’re transferring to, you may have to deal with service fees, and those are always a waste of money.

Somewhat paradoxically, the earlier you start investing in an IRA, the shorter this “long haul” will feel. If you invest $5,000 each year, just shy of the maximum contribution, starting at the age of 20, you’ll have an impressive amount of money by the time you’re 40, and those earnings will continue to compound. Meanwhile, if you don’t start until you’re 40, $5,500 a year isn’t going to feel like enough money to get you where you want to be when it’s time to retire. At this rate, your long haul might continue past your 65th birthday, and there’s no way to go back and save more when you were younger. See what I’m saying? The earlier you open your retirement account, the younger you’ll be when you start to feel confident about your retirement prospects.

Looking at your IRA through a long-term lens will also help with your investment strategy. When you have a long way to go before you retire, you don’t have to be overly cautious with your money, and you can expose your account to a little more risk in exchange for more reward. You’ll be able to sit calmly through the ebbs and flows of the market, knowing that the economy will forge ahead and good investments will withstand tumultuous times.

A well-constructed portfolio is a big part of long-term planning. This is my main concern with how people invest in their retirement; 401(k)s and mutual funds often underperform even while account managers bellow about diversification this and net return that. A lot more goes into creating a good investment account than buying up 500 different stocks. If you don’t take interest in your IRA, you could fall victim to an underperforming account as well.

However, if you go through a good company and read a book or two about investing, you can grow the wealth needed for a happy and successful retirement. I’ll say it again - you have to save for retirement. There are a lot of ways to go about it, but you need to have money invested that you’ll be able to live off when it’s time to stop working. You owe it to yourself, you owe it to your kids, and we all owe it to the communities we live in that will do much better if local retirees aren’t running out of money.

Hopefully you’ve learned a little about IRAs and feel ready to improve your financial future. If you already have an account with money growing, good for you. If this motivates you to get started on your savings, then good for both of us!

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