It is easy to set up a Roth or traditional Individual Retirement Account (IRA). Choose the bank, mutual fund, or other financial institution where you want to open an IRA account, fill out an application, designate a beneficiary, and make an opening deposit. Although you can contribute for the previous year up until April 15 of the following year, the earlier in the year that you deposit money in an IRA, the longer it will have to grow through compounding.
The maximum amount that can be contributed to either type of IRA in 2007 is $4,000. Investors age 50 and older can make an additional $1,000 catch-up contribution for maximum savings of $5,000. The maximum contribution amount for 2008 is $5,000, with inflation adjustments in $500 increments thereafter. IRA investors must have earned income (e.g., salaries and net earnings from a business) to make a contribution. Eligibility to contribute to a Roth IRA phases out at certain higher income levels.
Many people wonder where their IRA money should be invested. Virtually any security is appropriate for an IRA except one that is already tax-exempt (e.g., municipal bonds). The whole idea of an IRA is to defer taxes, and there is no point in tax sheltering something that is already exempt. Ditto for annuities, which are already tax-deferred. The major providers of IRA accounts are banks, savings and loans, credit unions, mutual fund companies, and full service and discount brokerage houses.
Here are some guidelines for selecting an IRA custodian:
• Banks, savings and loans, and credit unions offer a variety of fixed- and variable-rate certificates of deposit (CDs) for IRAs. Rates can vary several percentage points among institutions, so shopping around will pay off. Be sure that bank CDs are insured by the Federal Deposit Insurance Corporation or FDIC.
• Mutual fund companies provide a diversified portfolio of stocks and/or bonds for IRA investors. Fund families offer several choices of funds, such as growth, growth and income, bond funds, or money market mutual funds. Returns depend on the particular fund selected and how it performs. While there can be a large gain, there is also a chance of loss. In addition, the return depends on whether a commission (load) is paid or if there is no commission (no-load fund) and the amount of annual management fees.
• Full-service and discount brokerage houses offer a variety of IRA investments. Brokers can help an investor select a portfolio of stocks, bonds, mutual funds, and other investments. Returns depend on the securities selected and market performance. IRAs that let you choose among many different types of investments are known as “self-directed” IRAs. You make all the choices yourself. Discount brokers are appropriate for this type of account, particularly if you do your own research and don’t require “hand-holding.”
Costs for IRAs, including initial fees and annual maintenance fees, can vary so it is important to shop around. At banking institutions and no-load mutual fund groups, set-up fees are usually minimal or zero. There may be small annual maintenance fees. Full-service brokerage firms may charge an annual maintenance fee (e.g., often $50 to $75), payable separately or deducted from your account.