An individual retirement arrangement, or IRA, can be an excellent way to invest for retirement while keeping your taxes as low as possible. To find the best IRA for you, there are two things to consider: the different types of IRAs available, and the great variety of brokerages to choose from. Here's a guide to help you pick the best possible IRA for your long-term financial goals.
What type of IRA do you want?There are two main varieties of IRA accounts -- traditional and Roth. Both types have several things in common, including:
- You can contribute up to $5,500 for the 2015 tax year ($6,500 if you're over 50), and your contributions for a particular tax year can be made anytime between January 1 of that year and April 15 of the following year.
- Both accounts allow for tax-free compounding of investments -- you won't have to pay capital gains or dividend taxes each year.
- In both account types, you're free to invest in almost any stocks, bonds, funds, or CDs you want.
However, there are also several key differences to be aware of, the most significant of which is the tax treatment of contributions and distributions.
In a traditional IRA, you may be eligible to deduct your contributions on your current tax return, depending on your income, marital status, and whether or not you're eligible to participate in a plan at work. However, once you retire, your withdrawals will be treated as income for tax purposes. On the other hand, in a Roth IRA, you cannot deduct your contributions on your 2015 tax return. However, your eventual withdrawals in retirement will be tax free.
There are a few other differences between traditional and Roth IRAs, so here's a quick summary.
My general opinion about IRAs is that the Roth IRA is the way to go if you qualify under the income limitations,or use the backdoor method. While the traditional IRA tax deduction is certainly nice, the Roth's effective ability to "lock in" your current tax rate, combined with the overall flexibility of withdrawals, makes it a smart choice.
Self-employed? There are special IRAs just for youIf you're self-employed, you have a couple of extra IRA choices: the SIMPLE IRA and SEP-IRA.
Why are there additional IRA varieties? The logic behind it is that if you're self-employed, or own a small business, you don't have access to an employer's retirement plan like a 401(k). So both of these account types have higher contribution limits than either the Roth or traditional varieties.
The SEP-IRA allows for contributions of up to 25% of your total earnings, or $53,000 for 2015, whichever is less. The calculation can be a bit complicated, so here's more information about the SEP-IRA if you're interested.
The SIMPLE IRA has two contribution components: employee and employer (self-employed individuals are considered to be both). As an employee, you can contribute up to $12,500, with an additional $3,000 allowed if you're over 50. And as an employer, you're allowed to "match" your own contributions up to 3% of your total income. Here's a thorough description of the SIMPLE IRA for interested individuals.
Both account types are treated like a traditional IRA in the sense that contributions are made on a pre-tax basis. In other words, you can deduct contributions on this year's tax return, but your eventual withdrawals will be counted as income.
What brokerage should you choose?By far, the most important decision is the best type of IRA for you. So, you should first decide which of the account types best meets your needs, and then consider the different brokerages offering IRAs.
Once you choose a brokerage, there are some differences, but mostly these depend on personal preferences. For example, some brokerages charge slightly higher commission rates, but offer access to more research and investment tools, and offer new account bonuses, making them good choices for investors who want to thoroughly research their stock choices. Or some brokerages run by the major banks allow customers to link their IRAs with their bank accounts for convenience, making them good choices for those who want the easiest deposit and withdrawal options.
Just a few examples to illustrate the available brokerages (in no particular order):
- TD Ameritrade and E*TRADE are extremely popular, and both charge relatively steep $9.99 commissions on trades, but offer 60 days of free trading, as well as substantial bonuses for people who roll over or transfer an account. For example, E*TRADE offers a $200 bonus with a deposit of at least $25,000, and a $2,500 bonus with a $1 million rollover -- representing an instant 2.5% return on your investments. These two brokerages also offer state-of-the-art trading tools and access to lots of investment research.
- Discount brokerages like Trade King have lower commissions ($4.95), but tend to have fewer features than competitors.
- Bank of America's Merrill Lynch offers relatively cheap $6.95 commissions, as well as the ability to link an IRA to other Bank of America accounts.
- If you want to invest primarily in mutual funds and ETFs, you may be better off choosing an IRA through a mutual fund issuer like Vanguard. Through a Vanguard IRA, you can invest commission-free in the company's funds, which are already among the lowest-cost investment options in the industry. You can also invest in individual stocks with $7 commissions (or less, for those with high account balances).
The Foolish bottom lineThe most important decision to make is the type of IRA you want, which, for the majority of people, is a choice between a traditional and Roth. Once you figure that part out, do some research on brokerage firms, as commissions and bonuses can change over time, as can the features offered. There is no one "best IRA," but it's certainly possible to evaluate the options and determine the best IRA for you.
The article The Best IRA for Your Retirement originally appeared on Fool.com.
Matthew Frankel owns shares of Bank of America, and also holds IRA accounts at both TD Ameritrade and Merrill Lynch. The Motley Fool owns and recommends TD Ameritrade. The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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