An IRA or Individual Retirement Account is simply an account you use to invest your money for retirement. The beautiful thing about IRA’s is that they offer tax benefits, so it’s the perfect place to start investing, especially if your employer doesn’t have a 401K plan. Knowing how to open an IRA can seem daunting but we are here to show you it’s actually really simple.
There are two basic flavors of IRA accounts. Traditional IRAs and Roth IRAs. You can learn about both in our IRA guide.
Step 1 to Open an IRA: Decide Where To Open Your IRA Account
We love both companies for several reasons. First, they offer great low-fee index funds (Fidelity recently launched two index funds with ZERO fees!). Both have solid support if you need help with your account, and both are reliable and solid institutions. This means that you can expect documents to arrive on time during tax season. One less thing to worry about. Both offer their own brand of index funds, which means you’ll pay fewer commissions and fees. AWESOME.
We do NOT get paid a commission for recommending or promoting any investment company so just pick the one that works best for YOU and move on. You can’t go wrong with either one. If you have a spouse who already uses one of those institutions (or another one like Charles Schwab) it could make sense to use the same one to keep things simple for you. The most important part is just to get started.
One thing to note is that Vanguard has $3,000 minimums on many of their index funds, so if you go with them and you don’t meet those minimums you’ll have to start with ETFs like VTI, which is Vanguard’s Total Stock Market ETF. Many people find index funds easier to invest in since you don’t need to place market orders (it’s a little more complex to buy ETFs so many people just go with index funds).
With Fidelity, their low-cost index funds like FZROX (Fidelity’s ZERO Total Market Index Fund with no fees or expenses) have no minimums so you can start investing with as little as $100.
Step 2 to Open an IRA: Decide On A Traditional IRA Vs. Roth IRA
Deciding whether to open a Traditional IRA vs. a Roth IRA is like deciding if you want to go to Paris or London for vacation. You can ask a bunch of people and there won’t be a consensus about which one is better. But the one thing that’s for sure, is that spending a week at either destination is a hell of a lot better than going to work for a week.
Contributions to Traditional IRAs are tax-deductible and are made using pre-tax dollars. The deposits you make into a Traditional IRA will lower your tax bill this year. When you are finally ready to sell your investments and withdraw the money during retirement you’ll pay the income taxes on those distributions at that time.
Contributions to Roth IRAs are NOT tax-deductible and are thus made using after-tax dollars. The deposits you make into a Roth IRA won’t lower your tax bill this year. However, when you are finally ready to sell your investments and withdraw the money during retirement you won’t have to pay any taxes at all, since you paid taxes before the money went into the account.
So, which IRA is better?
It depends. We usually recommend Roth IRA’s to younger investors and Traditional IRA’s to older investors who might be in their top-earning years (and thus higher tax brackets). At the end of the day, the most important thing is to choose one and start investing since it’s tough to predict how much you’ll earn in the future, how tax brackets will change, and when you’ll be ready to withdraw.
We repeat, DO NOT LET THIS DECISION HOLD YOU UP from opening an IRA account, as the difference between the two won’t make or break what kind of retirement you will have (although not opening an IRA at all might!).
Step 3: Open Your IRA Account Online
You can open an IRA at Vanguard here or with Fidelity here. Opening the account, making a deposit, and choosing your investments will take very little time on your part. It took us 20 minutes to get set up and running. BUT that doesn’t include the few days it takes for the transfers and everything to process, so expect it to take 7 business days before you’ve finally gotten the confirmation that your money has finally been invested.
The application process to open an IRA will ask you to input some personal information. It’s also worth noting that you’ll need to have earned income in order to contribute to an IRA. If you don’t earn an income but are married AND file taxes jointly, you can make ‘spousal’ IRA contributions. So that’s something awesome for stay-at-home parents.
Another tip helpful for parents is that if your kids earn income (from babysitting, or other jobs), you can open an IRA for them. This would give them a huge head start when they become adults.
Step 4 to Open an IRA: Choose Your Investments
Choosing your investments is often cited as the biggest thing holding people back from starting to invest. But it shouldn’t because it can be SUPER simple and still be extremely effective.
You can go with a simple plan and choose an “all-in-one” fund or customize your investments. We recommend you keep it simple as you begin investing, and then venture out from there.
The easiest way to start investing is to choose an ‘all-in-one’ fund, which is formally called a target-date fund. These funds at Vanguard have a $1,000 minimum and expense ratios of 0.153% on average. You want expense ratios as low as possible since it’s the annual fees they keep. At Fidelity, their target-date funds don’t have minimums but have higher expense ratios. To keep things simple, expense ratios are annual fees you pay to hold a specific investment fund.
To choose a target-date fund you literally just have to choose the year in which you plan to retire. Buy the fund closest to that year. For example Vanguard has the Vanguard Target Retirement 2055 Fund (VFFVX). Fidelity has Fidelity Freedom 2055 Fund (FDEEX). Both are for those who want to target a retirement in the year 2055.
If you want to customize your investments more or pay lower expense ratios, you can set up a simple Two or Three Fund Portfolio. For most investors, this is more than enough and is still simple enough to handle on your own. Get the details you need to build your Three Fund Portfolio here: Three Fund Portfolio
Opening an IRA is easy, so don’t wait any longer. Remember this if you want your money to grow and work for you: The amount of time your money is in the market matters more than the amount of money you put in the market.