If you've heard opening up an individual retirement account is a smart first step toward a comfortable retirement, you're already ahead of many Americans. However, a number of consumers are unsure of how and where to open an IRA that best fits their needs.
Here are answers to the four commonly asked questions when it comes to opening, funding and setting up your first IRA.
1. Where should I open my IRA? An IRA is essentially a savings account with excellent tax advantages, so your first step should be deciding at which company you want to open your account – just as you would decide at which financial institution you'd open a savings account.
Ask yourself these questions when trying to determine the right place to open an IRA:
- Does the account offer access to a large mutual fund selection? Many offer upwards of 2,000 funds and exchange-traded funds to choose from, and ideally some of these will have no transaction fees.
- Does the account offer a low cost per stock trade? If you plan on becoming an active trader, you want to be able to execute stock moves at less than $10 per trade.
- Does the account offer no-fee transactions for certificate of deposit purchases, as well as access to the CDs with the best rates?
2. Do I go with a traditional or Roth IRA? Depending on your tax situation, you may want to open both. A Roth IRA differs from a traditional IRA in that instead of receiving a tax break when you deposit your money, you receive the tax break down the road when you withdraw the money.
This means if you expect your tax rate to go up, a Roth IRA would be preferable. But if you foresee your tax rate going down, a traditional IRA would be the best choice. If you're unsure where your tax rate is headed, open both types of accounts (if you can afford to) to diversify your retirement savings.
3. What types of investments should I choose? Make sure to have diversified asset allocation within your IRA. When selecting from a variety of funds and ETFs, it's best to choose ones with low expense ratios to minimize fees that would eat away at your returns over time.
However, keep in mind simply because a stock or fund performed well in the past doesn't mean it's guaranteed to do so in the future, so diversification is key.
4. Should I invest in a CD within my IRA? Another option to consider is investing in a CD within your newly opened IRA. By finding the best IRA CD rates currently offered by financial institutions across the country, you can be sure you are seeing the best rate of returns on your savings – even if you don't feel comfortable investing in higher risk-bearing options such as stocks and equities.
Clearing your retirement hurdles. Once you've opened your first retirement savings account, you'll have cleared the most intimidating hurdle you'll face on the path toward a successful retirement. Now that you know how to set up and invest within an IRA, opening the next retirement account – whether it be a 401(k), 403(b) or another type of account – will come that much easier.
Susan Lyon is a senior strategy analyst for NerdWallet Investing, a financial literacy organization that helps investors learn how to open IRA accounts, select better mutual funds and make smarter financial decisions.