Choosing The Best IRA Provider
An IRA is one of the most important tools you can use to save for your retirement. Most people retire with far too little in savings and retirement funds. This problem is getting worse as people live longer and often retire earlier. Most people realize too late that they haven’t saved enough – and by that time it’s too late to do much about it.
To retire comfortably you need about 25 times whatever you spend in a year. You can subtract social security and any pension you may be due from that annual figure – but it will still be a lot of money that you need to save.
To make sure you save enough, you should start as early as you possibly can, and use every tax break and savings vehicle available to you.
What exactly is an IRA?
IRA stands for Individual Retirement Account. An IRA is an account any individual can use to save for retirement. The account is a legal structure which has certain tax advantages that other investment accounts don’t have. Basically, the contributions you make to an IRA are tax deductible, and the money in an IRA can grow without being taxed. You will however be taxed at your income tax rate when you withdraw money.
Once you turn 59.5, you can begin to withdraw money from the account.
How much money can you contribute to your IRA?
There are limits to what you can contribute to an IRA each year. There are also limits and to the total you can contribute to all your tax deferred retirement accounts, including your 401(k). If you are under 50 you can contribute up to $5,500 a year to an IRA and if you are over 50 you can contribute $6,500. If you have already contributed the maximum to your 401(k) there may be some restrictions on the amount of your IRA contributions you can deduct from tax.
Your IRA contributions must come from normal employment income or from another IRA. You can’t use rental income, interest or dividends to fund an IRA.
Anybody under the age of 70.5 with a taxable income can set up an IRA. In addition, anybody, of any age can set up an IRA to receive assets from another IRA (see the Rollover IRA below).
IRAs vs 401(k)s
If you work for a company employing more than 50 people, you probably have a 401(k) account that you can contribute to. These retirement savings plans are like IRAs but a little less flexible. Many companies will match a portion of whatever you put into a 401(k). You should always try to maximize those employer contributions first, and then contribute to an IRA.
Types of IRAs
There are several types of IRAs:
Individuals can contribute whenever they want and those contributions will usually be tax deductible. The contributions then grow on a tax deferred basis, and tax is paid when money is withdrawn.
Roth IRAs allow individuals to pay the tax upfront on contributions. That means that you will not be taxed when you withdraw money from your Roth IRA. If you use a Roth IRA, you will be paying tax at your current tax rate, whereas with a traditional IRA you’ll be taxed at you tax rate during retirement. If you think your tax rate will be higher when you retire, then a Roth IRA is a good option as you will be taxed at a lower rate. However, that does mean you will have to pay the tax now, which will leave less in your pocket.
SEP stands for ‘simplified employee pension’, and this kind of IRA is used primarily by the self-employed or small business owners. SEP IRA’s can be used by both small business owners and by their employees. They offer tax advantages, and employers can contribute up to 25% of earned income each year.
A Simple IRA or Savings Incentive Match Plan for Employees (SIMPLE) is an IRA for businesses employing up to 100 people. Simple IRAs differ from SEP IRAs in that contributions can be a mix of employee contributions and employer matching contributions.
If you leave a job you’ll be given a choice of leaving your savings in your ex-employer’s 401(k) sponsored plan, or moving it into an IRA. This is where the rollover IRA comes in. A 401(k) plan will probably have a very limited range of investment options. If you are happy with the options available to you, there is no reason to move it. But, if you aren’t happy, you can move those savings to any IRA provider you want, and there will be no penalty.
What can you invest your IRA account in?
IRAs allow investors to invest in mutual funds, ETFs, shares, annuities and some real estate. We would avoid the last two for an IRA as they are not liquid. That means they are not always as easy to sell as they are to buy.
Mutual funds are portfolios managed by a professional investment manager. Most mutual funds are actively managed, which means the manager actively buys and sells shares in the fund using their discretion. You invest in a mutual fund by buying units directly from the investment management company, at the closing price for the units on the day you buy them. Usually there will be an upfront fee and an annual management fee.
ETFs, or Exchange Traded Funds, are funds that are listed on an exchange just like a share. Nearly all ETFs are passively managed. That means they replicate a stock market index and only make changes when the index is changed. ETFs have very low annual management fees and no upfront fees when you invest. However, because they are listed like shares, you must pay commission to a stock broker when you buy or sell them.
Choosing a provider
IRA providers tend to specialize in various types of clients. Some offer low commissions, which is great for active traders. Others offer great tools for those who need help making decisions. And others will do everything for you.
The best providers
These are some of the best IRA providers around, and their top selling points:
Wealthfront is robo-advisor which helps people manage and invest their savings. They are ideal for people who would like someone else to make all the decisions for them. Wealthfront charge a management fee of 0.25% a year, but the first $10,000 you invest is a managed for free. They do however have a minimum account size of $500. Wealthfront offers a great plan for saving for college.
Another robo-advisor for those who need help is Betterment. They charge a management fee of 0.25 to 0.5 % and have no minimum account balance. They also offer an initial period with zero management fees depending on the size of your account. One of the great features of Betterment’s service is that they have goal-based tools. You enter your investment objectives, and they work out the best strategy.
Charles Schwab is perfect for those who want to manage their investments themselves. Their commission on trades is a flat fee of $4.95 which is one of the lowest around. They also offer free trades for new accounts, depending on how big your account is. Their minimum account balance is $1,000.
For investors looking to manage their own investments and who want the best tools around, TD Ameritrade is a discount stock broker that offers a range of retirement products. They have no minimum balance and their commission rate is $6.95 per trade.
Vanguardare at the forefront of the ETF industry. They specialize in creating very cheap investment products. Their commissions range from $2 to $20 per trade depending on the size of the account, but they also offer access to some of the cheapest products around. If you like like to keep things simple, you’ll struggle to find better value.
Fidelityis a great all-round provider. They offer the best selection of actively managed mutual funds, and don’t charge transaction fees on those funds. But, you also get to trade stocks and ETFs for only $4.95. That means you have access to some of the best value mutual funds, as well as ETFs at low commissions. They also offer a fantastic research product for those who want to maximize their returns.
So, which one should you choose?
All the providers listed here are excellent, it just comes down to which one best meets your needs. For most people who have a small account and need help, Wealthfront is the best option. If you have a bigger account and want to get involved in managing your own account then TD Ameritrade or Fidelity are a good choice.
The above providers all offer these services within an IRA product, and as a standalone product. So, if you have already contributed the maximum you’re allowed to your IRA, you can still invest in all the same products. You won’t have the same tax benefits, but you’ll still be able to add to your savings.
In addition, almost all providers offer their services as part of a traditional or Roth IRA.
How to open an IRA
Once you have decided which IRA is right for you, setting up an account is very easy. Most providers have managed to streamline the process and you can do most of it online. In fact, it’s very much like opening a bank account. You will fill in your personal details and then they may require some form of proof of identification.
Once you have set up the account, you can begin to transfer money to the account and select your investments.
Some Tips on Selecting Investments
IRAs offer a very wide range of investment options, from stocks to ETFs and mutual funds. While this can be a blessing, it can also be a curse. A wide range of choices may cause you to make too many changes. You only need a handful of investments especially when your account is small.
Until your account reaches $10,000, stick to ETFs and mutual funds that invest in the entire market. You can also invest in funds that invest across Europe or Asia.
If your account is between $10,000 and $20,000 you could invest a portion of it in funds that focus on sectors or countries.
You should only invest in individual shares if your account is larger than $20,000. And then it should only be in quality, profitable companies. Individual shares should each be less than 5% of your portfolio, and collectively only make up 30 to 40% of the account.
What to avoid
It’s best to avoid niche funds or ‘hot’ industries. When an industry is in the news often, it’s often close to the top for that industry. IRA investments should all be for the long term. So, while its fine to invest in the ‘Tech’ sector, it isn’t a good idea to invest in one industry like the semiconductor industry. The same goes for ETFs that follow a particular theme.
You should also avoid shares in companies with a total value of less than $500 million, or companies that aren’t actually making profits. A retirement account is not the place for tech start-ups or small bio-tech companies.
An IRA is an ideal investment account to help you supplement your retirement savings. If you don’t want to get involved in making investment decisions, open an account with one of the robo-advisors like Betterment or Wealthfront. If you do want to get involved in the decision making yourself, make sure you have the time and discipline to learn about investing.
And remember, the biggest factor in determining how much you will end up with is not be the investments you make, but how early you start saving and how much you save.