How to start a retirement account: IRA accounts

This conversation happens too often:

"Do you have any retirement accounts?"

"Yes. I have an IRA."

"Great! What investments do you have in it?"

"Like I said, it's an IRA."

So let's demystify IRAs.

* IRA stands for Individual Retirement Account.

This is to differentiate it from a company retirement account, like a 401(k) or a pension plan.

* You probably have a regular IRA or a Roth-IRA (or both), unless you're self-employed.

Regular IRAs are also called Traditional IRAs or, if the money originally came from a company retirement account, a Rollover IRA.

* You can buy the same things in an IRA as you can in any other brokerage account.

The only difference between an IRA and any other brokerage account is how the IRS treats your contributions and distributions.

* The best place to keep an IRA is at a brokerage firm.

(e.g., Schwab, Fidelity, Vanguard, TDAmeritrade... it doesn't matter).

Banks also offer IRA accounts these days, but they usually limit what things you can invest in them. For instance, they might only offer investments that they themselves package. (They get more fees from you this way!) In a brokerage account, you can invest in nearly any stock, bond, CD, mutual fund, or ETF.

Should I start a regular IRA? Or a Roth IRA?

First let's talk about the differences.

Regular IRA:

With a regular IRA you put money in and you get that much of a discount on your taxes. After that, you only pay taxes on the money when you take it out. If you're 59.5 or older, the money you take out of it is taxed just like you earned it at a job. (If you're younger than 59.5 you get taxed the same PLUS a 10% penalty- that really adds up!)

Roth IRA:

With a Roth IRA you put money in and you don't get a tax discount. However, when you retire there is no tax at all! (Or so they promise. In 30 years who knows.)

So which is best? Generally speaking, if you don't make much money now you probably don't need the tax break, so a Roth IRA makes sense. If you are in a really high tax bracket, THEN it's a calculation. And also, if you make a lot of money (over $116,000 if you're single), you might not be allowed to contribute to your Roth at all.

People whose income is feast or famine often have both. In a year that looks it will have a high tax bracket (you got commissioned to do Big Art Project!) they will contribute to their regular IRA. In a year that looks like they won't make much, they'll contribute to their Roth IRA.

Of course there's fine print. Vanguard has a nice page here describing the differences.

BONUS!

If you make under $30,000 (for singles) and still manage to contribute to EITHER a Roth IRA or a regular IRA you can still get a tax discount! The government really really wants people to save for retirement!

The less money you earn, the bigger the discount.

If you make under $18,000 you will get a 50% tax credit

If you put in $50, you will get $25 back!

Here's the webpage that tells how big of a tax credit you'll have by income level.

How do I start an IRA?

There are a few ways.

• Go to one of the brokerage firms' websites and follow the links for opening an IRA. Many of them have a minimum but they will lower it if you promise to put money in automatically. You can tell them to put in $10 once a month or $100 every week if you want.

(If setting this up is too confusing, the customer service on all of these has been great, in my experience.)

Once you have a few hundred dollars built up you can buy one of their No Transaction Fee funds (or anything else, but you'll pay some fees.)

$500 is often the minimum for mutual funds, and many have minimums of up to $2,000.

Figuring out which thing to invest in is the tricky part. All of these brokerage firms have tools for sorting what's available, and of course you can hire me to help figure it out, too. That's a lot of what I do.

• Go to a brokerage firm's office and ask them to set up an account for you. Find out if this will change how you're charged for the account and in what ways!

• Go to a mutual fund company and open an IRA with them directly. Often this is a cheap and simple way to do it, but you are limited to that company's funds.

• Go to a bank and open an IRA there. I know I complained about them a few paragraphs up, but you can keep it at the bank until you have a few hundred dollars saved up and then transfer it to one of the brokerage firms.

How much should I put in?

If you are under 50, the most you can put in for 2015 is $5,500.

Have questions? Send me a message and I will clarify!