What's an IRA and How do I Start One?

What's an IRA?

IRA stands for "Individual Retirement Arrangement." It's a retirement account that you can use for yourself. It's probably the easiest retirement account for anyone to open, yet so many people are too afraid to even try it. It's not something that you buy, and it's not something that your company can create for you. It's an account (just like a bank account) that you can create for yourself.

There are 2 main types of IRAs

  • A Traditional IRA
  • A Roth IRA

A Traditional IRA is by far the most common type of IRA that people have. It works very similarly to a 401(k). A Traditional IRA allows you to "defer taxes." This means any money that you put into an IRA from your work doesn't have to count as income to you this year. You can wait until you retire and count it as income then. It's great because you can lower your taxes by putting money into the IRA. The downside is that you'll have to pay taxes at some point, and usually your account will be worth a lot more when you retire, so you might have to pay a lot in taxes in the future.

A Roth IRA is not as common, but arguably a better choice for young people. The Roth IRA doesn't let you defer taxes, so you don't get to write off your income like you can with a Traditional IRA. The Roth IRA has the benefit of not being taxable at all in retirement. Once the money is in the account, you can use it in retirement and not owe any taxes on it. This is usually great for people who want to plan their spending in retirement and not have to worry about setting any money aside for taxes.

How do I start an IRA?

Opening an IRA is easy. You just need to have a few things first:

  • Income
    • You'll need to have "earned income" in order to contribute money to an IRA. So no "under the table" money, no gift money, and no borrowing money to contribute. Nearly every broker will have a link online to transfer money directly from your bank account to the IRA, but if you're old school you can mail in a check too.
  • Some personal information
    • Just like opening a bank account, they'll need to know your address, SSN#, birthday, and possibly a few other personal details. Expect to have to scan or fax a copy of your ID in order to open the account.

That's it! You can choose any broker you like, some of the most common brokers are Fidelity, Vanguard, Charles Schwab, E*Trade, TradeKing, or TD Ameritrade. There are plenty of other choices though and each broker has its own pros and cons. The home page should have a button on the top to open an account. Click that, and choose IRA from the list of choices. You'll have to agree to some terms and conditions, but that's all there is to it.

Words of Caution

IRAs have limits to how much you can contribute in any given year, consult a financial adviser for specifics. (As of 2015 the limit was $5,500). Also, there is an income limit to who can benefit from an IRA. Again, consult a financial adviser to see if you qualify.