An Individual Retirement Account or IRA is a special investment account that provides tax incentives to people who are saving for retirement and other purposes. The two main types, the traditional IRA and the Roth IRA, have different rules and tax exemptions. When you set up an IRA you contribute money to it, but you must also decide how the money is to be invested. When you shop for a traditional IRA you will need to consider several factors including the cost to you and whether the provider has the services you need. The steps below explain how to understand what an IRA does and how to shop for a traditional IRA that fits your needs.
Learn how a traditional IRA works. In an ordinary investment account, you deposit money, make investments and withdraw money pretty much at will. When you liquidate an investment you report the profit or loss on your tax return. With an IRA it works differently. In the traditional IRA, as long as you are under 70-1/2 you can contribute a maximum of $5000 ($6000 if you are over 50) each year. The money you contribute is tax-deductible. The money, including profit, is not taxed until you withdraw money from the account. The traditional IRA is intended to be a retirement account and there are penalties for early withdrawal of funds. The other type of IRA (the Roth IRA) does not have the tax deduction on the money you contribute—but withdrawals are tax exempt. Roth IRAs are more commonly used for purposes other than retirement, such as financing a child’s college education.
Decide how you want to open a traditional IRA. Generally, you can go to your bank, a mutual fund company, or a brokerage. With a bank, fees are moderate and you are dealing with people you know. Mutual fund IRA accounts have the advantage that you can simply contribute money to the account and the fund manager does the investing for you (and charges a fee). Full service brokerages are more expensive, but offer a wide range of services. If you make your own investment choices, you probably will elect to use a discount brokerage. These often do little but execute your transactions, but they also cost less.
Read the fine print. Before you open your IRA account, get a complete list of all transaction fees and other charges. Be sure you select a “no-load” mutual fund if you choose to use this investment option. Some funds take as much as eight percent of your investment up front (and more fees later as well). No-load funds do not do this and you can find many that perform as well or better.
Select the type of account you want for your traditional IRA. Account types differ. Often, the account provider has special programs for IRA investors. Others can assist you in choosing a mutual fund or researching stocks. These options are more common with full-service brokerages, but you should check into them and decide what best suits your overall financial plan.
Open your IRA account. This is the easy part (firms want your business—so they make it easy). You will need to fill out an application (usually you can do this online) and make an initial deposit. Most firms require a $1000 minimum deposit. Then it's time to start investing. Always research any stock, bond or mutual fund carefully before you buy. If you sign onto an investment program offered by a bank or brokerage, make sure you understand the terms and ask to see how the program has performed in the past.
It’s a good idea to become familiar with the rules governing IRAs. Below is a link to the Internal Revenue website, which contains detailed information on all the rules and regulations pertaining to traditional and Roth IRAs.