Life is hard, but IRAs are easy!
Yesterday you heard me rave about 401(k)s, the best savings deals around. But if your company doesn’t offer it (or if you’ve maxed out your 401(k) contribution), here’s another easy way to save for retirement: Open an IRA.
IRAs are essentially super-smart savings accounts available to working people (and their non-working spouses). The deal is that Uncle Sam agrees not to tax the money in your retirement account and, in turn, you agree not to withdraw money until you’re 59½ or older. Big deal, right? But it could mean thousands of extra dollars in your lifetime, especially as the interest starts earning interest on itself. It’s similar to a 401(k), except you have to set up an IRA yourself—your employer won’t do it for you.
But relax, it’s relatively simple. Here’s what you need to do:
Decide how much to contribute.
Generally, you’re allowed to deposit up to $5,500/year (or $6,500 if you’re 50 or older). But don’t sweat it: You can start with as little as $1,000 through Vanguard’s STAR fund. T. Rowe Price also lets you open an account with $1,000 up front, or just $50/month through their Automatic Asset Builder service.
Find the right IRA for you – there are two main types:
- Traditional IRAs. With these, you get to subtract (or “deduct”) your contribution from your income. So if you earn $35,000 and contribute $1,000 to an IRA, you pay tax as though you had only earned $34,000. While your money is in the IRA, earning interest, you don’t have to pay taxes until you’re ready to withdraw the money, when presumably you will be in a lower tax bracket. If you have a retirement plan at work, you can still open one of these, but there are limits as to how much you can deduct. Check irs.gov for details.
- Roth IRAs. Unlike traditional IRAs, you don’t get to deduct your Roth contribution from your income. However, once your money is in a Roth IRA, it will never be taxed again. Your money doesn’t just compound tax-free—it stays that way forever. You can make the full $5,000 contribution to a Roth IRA if you’re single and your adjusted gross income is less than $120,000 (or $189,000 for a married couple filing jointly). Roth IRAs sometimes make the most sense for young people—but to figure out whether a Roth or a traditional IRA makes the best sense for you, look at IRA comparison calculators like the ones at morningstar.com and moneychimp.com.
Choose your company and funds.
You want to open an IRA at a no-load mutual fund company. Shop around to see which company and which funds charge the lowest expenses. As I mentioned above, Vanguard and T. Rowe Price are good options if you have little to invest. If you have at least $3,000, you can invest a portion of your IRA money in Vanguard’s S&P 500 index fund, which has an expense ratio of an appealingly low 0.14%. When choosing funds to invest in, I recommend a healthy mix of stocks (I like index funds) and bonds. If you’re terrified of losing money, you can put your cash in a money market fund, but that generally won’t keep up with inflation.
Remember, if you would like to make a IRA contribution for next year, you can contribute anytime from now until Tax Day in April.