If you are in the corporate world, chances are you have an employee sponsored 401k. If so, why do you even need an IRA? Why can’t you just open up an investment account and start investing in “fun” stocks?
The best thing you can do for your future is to take advantage of tax-deferred retirement options before you jump into investment accounts.
With standard investment brokerage accounts, you pay taxes on the money going in, and taxes on the money coming out.
With IRAs you either get to defer taxes on the contributed money or the money you withdraw. So, you essentially get to “skip” one set of taxes with an IRA.
This makes retirement accounts extremely beneficial to max out before you start contributing to investment brokerage accounts.
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What Is An IRA?
There are two main types of IRAs you can choose from. There is a Roth IRA and a traditional IRA. They are both Individual Retirement Accounts and can be opened in a similar manner.
A Roth IRA was established in 1997 and allows withdrawals on a tax-free basis.
A traditional IRA is allows individuals to direct pre-tax income toward investments that can grow tax-deferred.
Should You Choose A Roth IRA or A Traditional IRA?
There are a few key differences between a Roth IRA and a traditional IRA. The main thing to consider is whether or not your tax bracket will be higher in retirement than it is now. If you estimate you will be in a higher tax bracket in retirement than you are now, then go for the Roth IRA option. Otherwise, a traditional IRA would be a better option for you.
Many young people choose to go with a Roth IRA because they anticipate their tax bracket to be higher in the future. Also, if you already have an employee sponsored 401k, then you can diversify your retirement with a Roth IRA. Traditional IRAs act similar to 401ks tax-wise.
Roth IRA vs. Traditional IRA
| Roth IRA | ||
| Flexible early withdrawal rules | yes | no |
| Pay taxes on contributions | yes | no |
| Pay taxes on withdrawals | no | yes |
| Minimum distribution rules (once retired) | no | yes |
NerdWallet has this educational article about the differences between Roth IRA and traditional IRA.
Read: 10 Strategies To Start Investing
Are You Eligible For A Roth IRA?
Not everyone is eligible for a Roth IRA. As of February 2021, here are the questions you should answer to determine whether you’re eligible to take advantage of a Roth IRA:
- Was your modified adjusted gross income (MAGI) less than $139,000 in 2020? (For single filers)
- Was your modified adjusted gross income (MAGI) less than $206,000 in 2020? (For married people filing jointly)
- Did you earn taxable income last year?
If you answered yes to those questions, then you can start researching whether it makes sense for you to open a Roth IRA! If you do not qualify, then look into backdoor Roth IRAs!
Read: Dave Ramsey’s 7 Baby Steps (For Millennials)
How Start A Roth IRA
Now that you’ve decided whether or not a Roth IRA is right for you, it is time to open one! It takes less than 30 minutes to open one but here are some steps to get you started:
If you don’t know how to invest your money in your Roth IRA, call the customer service lines for your account and ask them to help! I use Fidelity and Schwab and their customer service has been incredibly helpful and they even sent me video tutorials.
1. Choose the right account for you!
The three most popular account options are with Charles Schwab, Fidelity and Vanguard. They’re all pretty similar but they offer different investing options and fees. Here are the best Roth IRA accounts in 2021 according to NerdWallet.
2. Open your IRA account
Each of the aforementioned account options will walk you through how to open them and have customer service phone operators as well as chatbots!
3. Transfer money into your account
Be sure to research the maximum contribution limits. As of 2021 they are $6,000 and $7,000 if you’re older than 50.
4. Research where to invest your Roth IRA
This is a huge mistake that many people make (myself included). If you do not invest your Roth IRA then your money just sits there as cash and doesn’t grow.
5. INVEST THE ROTH IRA MONEY
Do your research to decide what to invest in!
Example: if you want to invest in index funds, then Google “best index funds for Roth IRA for Fidelity in February 2021”. The internet is full of tons of research and helpful blog articles about where to invest!
6. Pay attention to expense ratios
Bankrate does a good job of listing the best index funds to invest in and sharing the expense ratios associated with each fund! Do not just blindly invest- do your own research and take the expense ratios into consideration!
Did you find this helpful? With investing, time is your biggest asset, so even if you’re investing a few dollars a day it will compound and future you will be grateful! Here are 10 more strategies for beginner investors.
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CAVEAT: I am not a financial advisor. Please do your own research!
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