An IRA is an “independent retirement account” typically used by small businesses and individuals who don’t have a retirement plan through their employers. An IRA is a very effective way to save money for retirement. It lets you diversify investments, and you can either handpick those investments, work with an advisor, or choose a collection of investments based on your risk tolerance.
The best IRA for beginners varies based on your current and projected financial situation. This guide outlines the different types of IRAs and explains what to consider when opening your first IRA.
Types of IRAs
The two main types of IRAs are traditional and Roth IRAs, but there are also specific types of traditional IRAs designed for small business owners and employers. Here are the main types of IRAs and their distinguishing features:
Traditional IRA
You make pre-tax contributions to a traditional IRA, meaning you don’t pay income tax on the money you put into these accounts. You do face tax on the withdrawals you make during your retirement, though. You can contribute up to $6,000 per year or up to $7,000 if you are 50 or older, as of 2021.
Roth IRAs
The contributions to a Roth IRA are not tax-deductible, but you don’t have to pay tax on the money you withdraw during retirement. You can also make withdrawals before retirement without facing any penalties.
The contribution limits are the same as they are for traditional IRAs, but you can only contribute to a Roth IRA if you earn less than $114,000 per year as a single person or less than $181,000 as a married couple filing jointly.
Simplified Employee Pension Plan (SEP) IRA
A SEP IRA is a type of traditional IRA that must be set up by a business or a self-employed person. Contributions can only be made by the employer — this means that a self-employed person or a freelancer can make contributions on behalf of themselves, but the contribution limit is 25% of their net earnings up to $58,000 per year as of 2021.
Savings Incentive Match Plan for Employees (SIMPLE) IRA
The SIMPLE IRA is another type of traditional IRA for businesses, and it is particularly attractive to small employers who don’t have the resources to set up a complicated retirement account.
Employees can contribute up to $13,500 to a SIMPLE IRA per year and up to $3,000 extra if they are 50 or older. Employers must either match their employee’s salary deferrals up to 3% of their compensation or make a nonelective contribution of 2% of their employee’s compensation.
The right choice between a traditional and a Roth IRA depends on your tax bracket now and your expected tax bracket during retirement. People who anticipate being in a higher tax bracket during retirement may want to choose a Roth IRA, so they can pay tax on the funds now at a lower rate. People who are likely to be in a lower tax bracket during retirement should opt for a traditional IRA, so they can defer the tax liability to retirement. You also need to ensure you meet the requirements for your chosen investment.
What to Consider When Investing in an IRA
Choosing the type of IRA is just the first decision you need to make. There are several other points to consider as you set up your IRA. You should talk with an investment advisor about the following items:
1. Your Risk Tolerance
All investments have a certain level of risk. A general rule of thumb is the greater the risk, the more potential for higher rewards. Less risky, more conservative investments, on the flip side, tend to offer modest returns.
Your risk tolerance changes during your life. Young people have time to ride the ups and downs of the market, meaning they have more tolerance for risk. People who are closer to retirement need to conserve their wealth and try to ensure their investments beat inflation, and by extension, they have a lower risk tolerance.
You also have to consider your personal preference. You can rely on the basic guideline of reducing your risk tolerance as you get closer to retirement, but you also must ensure that you’re not making investments that keep you up worrying at night.
2. Underlying Assets
IRAs can include a mixture of underlying assets. Many investors let their fund manager choose the investments based on their risk tolerance, but if desired, you can handpick the stocks and mutual funds in your IRA.
You can even invest in less conventional assets such as gold, silver, and real estate. You might also choose to explore a theme in your IRA, such as only investing in companies committed to corporate social responsibility.
3. Additional Retirement Accounts
The Internal Revenue Service (IRS) limits the amount you can contribute to your IRA, and as of 2021, you can only contribute up to $6,000 per year or up to $7,000 if you’re 50 or older. This is the total contribution you can make to all your traditional and Roth IRAs.
You may need to explore additional retirement account options if these limits don’t meet your savings goals. A retirement advisor can help you determine how much you need to save based on your expectations for your retirement.
There are many different companies that can help you set up an IRA, and when making your choice, you should try to focus on those that can provide you with independent advice. You don’t want to work with an advisor who is simply a sales rep for the investments their company offers — you want someone who has your best interests in mind and who can advise on risk tolerance, underlying assets, and whether or not you need additional retirement accounts.
Contact Bogart Wealth to Talk About Retirement Today
Bogart Wealth provides independent advice that can help you make the best investment and estate management decisions for your situation. Contact us today at Bogart Wealth, and we can help you choose the best IRA for beginners and guide you to the most effective retirement savings options for your needs.
