Though there are different savings avenues you can take to build your nest egg, the IRA, or individual retirement account, is one of the most useful tools and least restrictive options for working Americans. If your goal is to make the most of your IRA, here are four moves to make right away.
1. Open an IRA immediately if you don't have one already
There's a reason a large number of Americans don't have a 401(k) -- over 40% of workers aren't given access to an employer-sponsored plan. Saving with an IRA, however, is much simpler, as you don't need to work for a particular company to open one. Yet surprisingly, 33% of Americans don't have an IRA. If you're one of them, now's the time to get that paperwork rolling. The sooner you begin saving with an IRA, the more time you'll give your money to grow.
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As an example, saving $3,000 a year in an IRA for 25 years would leave you with an ending balance of about $190,000, assuming your investments generate an average annual 7% return. But if you only leave yourself 15 years to save that much, you'll have just $75,000 for retirement. The power of the IRA lies in its tax-deferred (or, in the case of a Roth, tax-free) growth, so the sooner you get started, the more opportunity you'll have to capitalize on the beauty of compounding.
2. Max out your contributions
Though IRAs don't come with the same generous annual contribution limits as 401(k)s, they still offer a sizable savings opportunity -- especially if you max out your contributions year after year. Currently, workers under 50 can contribute up to $5,500 annually to an IRA. If you're 50 or older, you get a catch-up allowance that raises the limit to $6,500. If you were to max out your IRA at $5,500 a year from age 30 to 50, and then max out your contributions at $6,500 from age 50 to 65, you'd have an impressive $785,000 in time for retirement, assuming an average annual 7% return on investment.
3. Convert your traditional IRA to a Roth account
Traditional IRAs are an appealing savings option because contributions are made with pre-tax dollars. The downside, however, is that withdrawals in retirement are subject to taxes, and once you turn 70 1/2, you're required to start taking minimum distributions from your account.
Roth IRAs, on the other hand, don't offer an immediate tax break for contributing, but once that money is in your account, it gets to grow tax-free. Better yet, when the time comes to take withdrawals, you won't lose a dime to taxes. Furthermore, Roth IRAs don't impose required minimum distributions, so you can let your money sit and grow for as long as you'd like.
That said, not everyone can contribute to a Roth IRA directly. Currently, you can't fund a Roth if you make more than $133,000 a year as a single tax filer, or $196,000 as a couple filing jointly. What you can do, however, is contribute to a traditional IRA and then covert that account to a Roth. Now if you go this route, you'll have to pay taxes on whatever amount you move over the year your conversion takes place. But if you're able to manage those added taxes, you stand to reap the many benefits of a Roth later in life. Even if you can't convert your entire IRA to a Roth, moving over even a portion of your savings could prove quite beneficial in retirement.
4. Find low-fee investments
Once you contribute to an IRA, you get to choose how your money is invested. While mutual funds are a popular investment choice for IRAs, they also tend to come with high fees that can really eat away at your returns over time. A better bet is to look at index funds, which typically offer significantly lower fees. Funds like the Vanguard S&P 500 ETF (NYSEMKT: VOO) give you broad exposure to the market at a minimal cost, which can be instrumental in building your nest egg. Remember, as your assets grow over time, the amount you'll lose to fees will increase as well, so the more low-cost investments you have in your IRA, the more you ultimately stand to gain.
The choices you make with your IRA could have a huge impact on your retirement. If you start saving as early in your career as possible, max out your yearly contributions, put some money into a Roth, and limit your investment fees, you'll be setting yourself up for a financially secure future.
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