What to Look for When Opening an IRA
September 28, 2011In response to the recent recession, employers are being forced to reduce or eliminate contributions to their employees’ retirement accounts. This, combined with projected reductions in Social Security benefits, is causing some employees to look for ways to save more for retirement. Most can accomplish this by increasing their contributions to their employer-sponsored retirement plan (e.g. 401(k)), but for those without such a plan, or are already contributing the maximum to the plan, they may need to start saving money in an individual retirement account, a.k.a. an IRA.
When contributing to an IRA, there are three things to consider:
1. Which type of IRA should I open?
There are two types of IRAs: a traditional and a Roth. Which one is right for you will depend on how much money you make and when you believe income tax rates will be higher. In general, if you think income taxes will be higher while you are working and lower in retirement, it makes sense to contribute to traditional retirement accounts. On the other hand, if you believe income taxes will be higher in retirement (and thus lower today), then it probably makes sense to contribute to a Roth account. There are income limits associated with IRAs, so here are a few resources to help you with your decision:
What is a traditional IRA and can I deduct my contributions?
What is a Roth IRA and am I eligible to contribute?
Why I Love the Roth IRA (and You Should Too)
2. What type of investments do I want to own in my IRA?
The type of investments you want to hold will determine where you establish your IRA (i.e. your IRA custodian). If you are a conservative investor and simply looking for safe investment options, you may want to open your IRA at a bank or credit union, or use a fixed annuity from an insurance company. Banks and credit unions typically use CDs and money market savings accounts for their IRAs, and a fixed annuity offers a guaranteed interest rate for a fixed number of years.
For investors comfortable with market volatility, consider opening an IRA with a brokerage firm or mutual fund company, or use a variable annuity from an insurance company. An IRA with a mutual fund company will often give you access to a range of investments, but generally limited to just those managed by that company. A variable annuity can offer a broader range of fund choices along with certain guaranteed income and death benefits not offered by mutual fund companies. If you are looking for the greatest investment flexibility, a brokerage firm allows investors to invest in just about any retail stock, bond, or mutual fund. Certain brokerage firms may even allow investors to hold real estate, commodities, proprietary, and nontraditional investments.
3. How much does it cost?
Just as there are different kinds of investments, there are different kinds of fees. The three main types of fees are custodial fees, transaction fees, and investment management fees. Not all IRAs will have fees; it depends on who your IRA custodian is and what you choose to invest in. Here’s what to look for:
No-Fee IRAs
A custodial fee is one charged by the IRA custodian simply for having an account with them. This fee is used to pay for recordkeeping, generating statements, and other administrative costs associated with having an IRA. Some custodians charge this fee, others don’t, so ask your financial institution if they charge any kind of fee simply for having an IRA.
No load, no transaction fee investments
Depending on the type of investments you are using, or the advice you receive, you may have to pay a transaction fee. When you purchase mutual funds through a financial advisor, or buy individual securities in a brokerage account, you generally have to pay sales charges and/or commissions. If you don’t need the advice, you can purchase “no load, no transaction fee” funds, or buy securities at a discount. Ask your custodian what type of “no load, no transaction fee” investments they offer.
Low expense ratios
Mutual funds, variable annuities, and other “pooled” accounts will have investment management fees that compensate the portfolio manager, so look for investments that have low expense ratios. In general, index mutual funds and exchange traded funds (ETFs) will have lower management fees than actively managed funds. Make sure you know the expense ratio before investing in any fund.
An additional note about variable annuities
A variable annuity has additional contract charges associated with the guaranteed income and death benefits. These contract charges reduce the performance of your investments, so make sure you fully understand the value of these benefits and the cost associated with them before selecting this investment vehicle.
Once you decide what type of IRA to use, and where to establish the account, then it’s just a matter of funding it. You can send a check, make a wire transfer, or set up automatic contributions from a checking account. You have up until April 15th (or the tax filing deadline, whichever is later) of the following year to make an IRA contribution for the current tax year. For 2011, you may contribute up to $5,000 (or $6,000 if age 50 plus), subject to income limitations.