Opening an IRA account can be tedious and overwhelming, but it doesn’t always have to be. Here’s a step-by-step guide for anyone looking to open an IRA account.
How to Open an IRA Account in 9 Simple Steps
What is an IRA? An Individual Retirement Account (IRA) is a type of savings account in the United States. It can help account holders build their retirement savings with tax-free growth.
Step 1: Understand the Benefits of an IRA
Before deciding to open an IRA account, it’s best to learn about the benefits associated with it.
Opening an IRA brings a multitude of benefits, such as:
- Tax savings: Having an IRA account can help boost tax savings. It can help save taxes annually by providing them with tax deductions and other tax benefits upon withdrawing the account’s earnings.
- Tax-free investment growth
- Traditional IRA: Contributions may be tax-deductible with a Traditional IRA, subject to the prescribed IRS limits. Earnings made from a Traditional IRA are subject to tax upon withdrawal.
- Roth IRA: With a Roth IRA, contributions may not be tax-deductible, but earnings may be tax-exempt.
- Compounded earnings: Contributions in an IRA account gain interest and dividends, and compound annually without incurring tax liabilities.
- Wider investment options: An IRA account also has the added benefit of having a wide selection of investment choices. Anyone looking to diversify their portfolio can do so by investing their IRA in stocks, mutual funds, bonds, and even precious metals.
Step 2: Determine the Type of Investor You Are
The next step is to decide which type of investor you are.
An independent investor prefers being on top of all investment-related decisions. These types of investors may opt to open an IRA account with an online broker.
Coordinating with an online broker may help the potential investor avoid an account-opening fee. They may only need to look out for commission expense, along with other investment fees.
Passive investors may opt to consult with remote IRA advisors or a robo-advisor. These advisors can choose and maintain one’s IRA portfolio for a small fee, which can range from 0.25% to 0.50% of the total investment.
Step 3: Choose the IRA Type
The two common types of IRAs are the Roth IRA and the Traditional IRA. Here’s how they differ.
The Roth IRA is a type of account you can fund with your post-tax income.
- Tax: Your contributions to a Roth IRA aren’t tax-deductible, but your returns on investments won’t be subject to tax when you finally withdraw them.
- Contributions: For 2019, the IRS allows for higher annual IRA contributions up to $6,000. Those who are at least 50 years old may contribute up to $7,000 annually.
- Withdrawal of Distributions: If you’re already 59 ½ years old, and have maintained your IRA account for at least 5 years, then you can take distributions from your IRA without incurring federal taxes. You can use such distributions to pay for any expense that you wish, and even pass down money to your heirs.
- Tax: All Traditional IRA withdrawals are subject to ordinary income tax. It doesn’t depend on income level. One may opt to choose their desired contribution level, which is only subject to tax upon withdrawal of earnings.
- Contributions: Starting 2019, the annual contributions for a Traditional IRA has gone up to a maximum of $6,000, and will also go as high as $7,000 for those at least 50 years old.
- Withdrawal of Distributions: Opting to withdraw early incurs a 10% distribution penalty fee.
Step 4: Check Eligibility
After deciding on the desired level of involvement and IRA type, it’s time to check eligibility. IRA providers usually ask for the following information:
- Current age
- Marital status
- Latest annual tax filing status
- Latest modified adjusted gross annual income
- Access to a retirement plan from your employer, if any
They then assess the potential investor’s profile and match it with the corresponding requirements that each type of IRA imposes.
Step 5: Choose the Investments
As previously mentioned, there are a multitude of IRA investment options. Here are some examples:
- Private businesses: It’s possible to invest in private companies by investing in their equity or debt, which may be represented by stocks and bonds.
- Funds: Those looking into opening an IRA account may also opt to invest in different funds, like mutual funds, index funds, and exchange-traded funds (ETFs). These funds are managed by a professional fund manager from a pool of money from different investors.
- Public investments: Public investments, such as publicly registered businesses, can also be added to one’s portfolio and may be done through a brokerage account.
- Real estate: Another option is investing in real estate properties, such as land, condominiums, and commercial buildings. Anyone looking to invest in real estate should take note though that it will be subject to IRS-mandated rules
- Precious metals: Precious metals, which include, gold, silver, and platinum, are also one of the investment options potential investors can look into. There are different IRA custodians offering this option, such as banks and other financial institutions.
Step 6: Open an IRA Account Online
After choosing the desired investments, it’s time to open an IRA account online with an IRA provider.
The first step is to download the application form.
The provider may require applicants to provide general information, such as:
- Contact information
- Birthdate and address
- Social Security number
- Employment details
- Mode of account contribution
Applicants may submit the completed application form via mail, along with the check for the initial payment.
Step 7: Fund your IRA Account to Start
Upon applying for an IRA account, the provider will ask your preferred mode of payment for the contributions. This can depend on your provider or if you already have an existing account or fund.
- Bank: If the IRA provider is a bank, you may be allowed to pay via funds transfer or submit check payments. You can also set up an automatic bank transfer, to avoid missing payments.
- Existing Account or Fund: If you already have an existing IRA account, a 401(k), or another retirement fund sponsored by your employer, you can opt to open a USAA type of IRA account. Then, you can roll over your existing account into your new account.
Contributions shouldn’t exceed the limit to avoid incurring an IRS penalty. The IRS limit is applied across all other IRS accounts as well.
Step 8: Name the Beneficiaries
An IRA account may have primary and contingent beneficiaries.
An IRA account’s primary beneficiary can be the account holder’s spouse, child, grandchild, or a trust. The degree of relationship between the investor and the beneficiary has effects on the movement of the assets.
- A child or a grandchild who is a primary beneficiary can’t use the IRA account that he or she inherited.
- A non-spouse beneficiary is not allowed to contribute to the IRA account.
What is a Primary Beneficiary? A primary beneficiary refers to the person or entity who is first in line to receive an IRA account’s assets if the account owner passes away.
The IRA account owner can decide how the IRA inheritance process proceeds in case of his or her death, or if the primary beneficiary dies.
Usually, account owners place their spouse as a primary beneficiary and their child or grandchild as a contingent beneficiary.
What is a Contingent Beneficiary? A contingent beneficiary acts as a substitute beneficiary in case the primary beneficiary dies before the IRA account owner.
Step 9: Manage the IRA Account’s Record Keeping
In line with making regular contributions, account holders should also manage proper documentation for all IRA account transactions.
It’s important to keep copies of all the receipts and other important document used in filing taxes. These documents can be any trust records such as:
- Financial reports
- Income statements
- Statement of investments
- Approval letters, notices, and any document acknowledging payments and contributions may be kept
These documents can be used as proof of timely IRA contributions and tax payments in case the IRS asks questions.
When setting up your IRA account, it’s essential to learn about its benefits first. It’s also equally important to choose a reputable IRA provider that can guide you in choosing investments.
Time is also one of the most important factors. The sooner an IRA account is opened, the bigger the compounded earnings will be.
Once an IRA account has been set up, account holders should keep a paper trail of all contributions and tax payments. With proper record keeping, account holders can avoid unnecessary hassle and ensure smooth payments.
What is your preferred IRA type? Let us know why in the comments section below.