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Planning and Investing

How to open an IRA in 5 steps

Although retirement may seem too far away to think about for some of us, it’s important to remember that, as with any type of saving, the sooner you’re able to start, the better.

One of the best ways to save for retirement is with an individual retirement account, or IRA. 

Employers sometimes offer retirement plans called 401(k)s, but if your employer doesn’t, IRAs are sometimes the best option. These accounts are like savings accounts, although once your money is in an IRA, you’ll pay steep fees if you take it out early. 

Retirement plans come with both tax advantages and, ideally, significant returns on the money you put in. 

Here, we’ll discuss some general best practices for opening an IRA to save for retirement.

It’s never too early or too late to start saving for retirement

Here’s one way to stay on track for retirement—dream of all the places you want to travel while squirreling away the most money you can into your retirement savings. 

Most Americans are not on track for a smooth-sailing retirement. According to CNBC, the median 401(k) balance in America is just $35,345 as of 2022.

That’s a far cry from the guidelines suggested by retirement experts. For example, according to T. Rowe Price, employees should aim to have a certain multiplication of their salary set aside for retirement.

  • Age 30: half of salary saved today

  • Age 40: 1.5x to 2.5x salary saved today

  • Age 50: 3x to 6x salary saved today

  • Age 60: 5.5x to 11x salary saved today

  • Age 65: 7x to 13.5x salary saved today

A recent Varo survey1 showed that 55% of people don’t even have $500 ready to tap in an emergency—and that percentage jumps to 61% when just considering millennials. In the same survey, only 4 in 10 people of all ages said they even had access to an employer-sponsored retirement plan and 45% didn’t have a savings account.

The good news? It’s never too early, or too late, to start planning. Part of your success in doing so relies on developing a saver’s mindset and taking advantage of the benefits an IRA offers.

What is an IRA?

An IRA is a type of retirement plan that is commonly used either instead of or in addition to an employer retirement plan, or 401(k).

Opening an IRA is a lot like opening a savings account. The main difference between an IRA and a savings account are the returns you make on your money, tax advantages, and penalties for taking out money before the age of fifty-nine-and-a-half.

Money you put into an IRA gets invested, unlike a savings account, which simply earns interest. Provided you make good investments, your IRA generally grows over time. 

There are many ways to invest in an IRA, but you can start by asking your bank or financial institution for recommendations.

Roth vs. Traditional IRA

There are two types of IRAs—Traditional and Roth.

Traditional IRA

Traditional IRAs let you deduct the amount you put into your IRA from your tax payments. However, the IRS limits how much you can contribute to your IRA each year. 

As of 2023, the  limit is $6,500 for people ages 49 and under. If you’re 50 or over, the limit is $7,5002

In addition to the limit, if you or your spouse contributes to a retirement plan through work, you may not be able to deduct all of your contributions3.

Between now and retirement, your contributions grow tax-free, but when you do retire you have to pay taxes on the final amount you withdraw from your IRA.

There are also Simplified Employee Pension (SEP) IRAs, which are intended for business owners and self-employed professionals. Similar to a traditional IRA, you contribute pre-tax earnings and pay taxes on withdrawals during retirement.

Roth IRA

The main difference between traditional and Roth IRAs is that Roth IRAs are not tax deductible. 

You will pay taxes on the money you contribute to your Roth IRA the year you put money in, but not when you pull out during retirement or on your return. 

Roth IRAs also have maximum income limits in terms of what you can contribute, so it’s a good idea to check what the current limits are when determining how much you want to put in each year. 

Choosing the right IRA

It’s best to think about IRAs like this—if you think taxes will be higher when you retire, put your money in a Roth. If not, go with the traditional.

You can also open and contribute to both a traditional and Roth IRA to hedge your bets.

It pays to do your research, and if you can afford it, it’s usually a good idea to review your options with a financial advisor.

How to open an IRA

Once you decide what type of IRA is right for you, it’s time to set it up. Here’s a step-by-step guide.

  1. Choose what type of IRA: Select either Roth vs. traditional based on what was outlined above.

  2. Choose a financial institution: You can open your IRA with a bank, credit union, mutual fund company, or another financial institution. Look for IRAs with low management fees and read reviews before settling on a specific institution. And if you’re going to want help managing your IRA, look for an account that comes with a broker. If you prefer a more hands-off role, robo-advisors, which offer risk-based investment options and automatic portfolio balancing, may be a better choice.

  3. Open your account: Once you’ve selected a financial institution, follow the instructions on their website or call to speak with a representative that can guide you through the process. You’ll typically need a government-issued ID, such as a driver's license or passport, as well as personal information like your name, phone number, address, date of birth, and Social Security Number. If you’re planning to contribute money via electronic transfer, you’ll also need your bank account information handy.

  4. Choose your investments: As you open your account, you’ll probably need to choose how the money you put into it gets invested. Some companies will suggest investments, which can be useful if you are new to investing. Others will simply ask you the level of  risk you want to take on with investments and take it from there. A common strategy is to take more risks when you’re younger, then less as you near retirement.

  5. Fund your account: Now, it’s time to put money into your IRA. Some companies ask you to make a deposit right away, but after that, you’ll have to decide if you want to make regular payments or a lump sum at the end of each year. Take a look at your budget, and track both your spending and income to see what works best for you in terms of the amount you can contribute.

Adopting a saver’s mindset

Even though it may feel daunting at first or too far away to wrap your head around, saving up for later in life is still important to do. If you haven’t started yet, you shouldn’t feel like it’s an impossible feat to manage. As we said before, it’s never too early or too late to start saving for retirement.

Let’s say you start by saving $10,000 into a retirement account by age 30. Even if you don’t contribute another cent and invest wisely with a 10% growth, you could, in theory, double your nest egg every 7 years. That same $10,000 you initially invested at 30 could be worth $640,000 by the time you retire at 72. When it comes to retirement saving, it’s helpful to take the mindset of putting your money to work for you instead of working for your money. 

It’s also worth keeping in mind that building your retirement fund is a marathon, not a sprint. Even if you’re not saving a large amount at first, you’re already in better financial shape for the future than you were before. The important thing is to maintain a savings mindset, contribute regularly as best you can, and watch your account grow over time.

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