5 smart moves for a successful IRA
IRAs are supposed to be easy. And, generally speaking, they are.
The government created individual retirement accounts, or IRAs, to encourage people to save more for their retirement and provided tax benefits to make them more attractive.
They're simple to open.
Just go to the website of any bank or mutual fund company, such as Vanguard or Fidelity Investments, and you'll be up and running in a matter of minutes.
Then all you'll need to do is follow these smart moves to turn your IRA into a successful way to save and build real financial security for you and your family.
Smart move 1. Make regular contributions.
The biggest key to every retirement plan can be summed up in one word: Contribute.
Once you've opened an IRA, set up a regular monthly contribution through an automatic withdrawal from your paycheck or bank account.
Start small, if you have to. It's better to get going with a modest monthly contribution than it is to wait.
The government says you can contribute up to $5,500 annually to your IRAs until you hit 50 years old. Then the ceiling goes to $6,500.
Those are total limits for all your IRAs. Some people set up more than one, often a traditional IRA, in which contributions are tax-deductible, and a Roth IRA, where contributions aren't deductible but later withdrawals are tax-free.
You can claim a tax deduction for a traditional IRA up to the maximum contribution, although the deduction can be limited if you or your spouse are covered by a retirement plan at work and your income exceeds certain levels.
Click here to find all of the contribution rules and income restrictions for 2015 and 2016.
Smart move 2. Use target-date funds to keep investing simple.
You can hold a dizzying array of investments in an IRA, everything from ultra-safe Treasury bills and certificates of deposit to more risky corporate stock and some real estate.
As a general rule, you want to take on investments with both more risk and potential reward, such as stocks, when you’re young and then move to safer investments as you near retirement.
That's what makes target-date funds, a type of mutual fund that holds a mix of stocks and bonds, such a smart choice for IRAs.
The balance of those investments is adjusted as you get older, so the emphasis shifts from higher earnings to security as you age.
All of the major mutual fund companies have them, and all you really have to do is choose the one "targeted" to the year you hope to retire. It's the closest thing to a "buy and forget" investment around.
Smart move 3. Choose a low-fee mutual fund.
Paying excessive fees for a mutual fund is like having a slow leak in your retirement savings, draining money that should be filling up your account.
Over the life of your IRA, even a small difference in annual fees can amount to thousands of dollars.
You should avoid a mutual fund that charges more than 1% a year in fees and other costs, known as the "expense ratio."
The good news is that it's easy to find target-date funds with expense ratios considerably lower than that.
Vanguard's target-date funds, for example, currently charge 0.14% to 0.16% a year.
Smart move 4. Take advantage of rollover provisions for old 401(k)s.
Most of us will switch jobs several times over our lifetimes. This means we're likely to have money in 401(k) plans at our old jobs as we move on.
Your old employer probably will cash you out of your old plan. That check can feel like free money, but if you just spend it or stick it into a regular savings account or CD, you're going to be hit with taxes and a 10% penalty unless you're at least 59½ years old.
What you want to do is roll over that money into an IRA.
It's incredibly easy to have the custodian of a 401(k) plan directly transfer the money to the bank or mutual fund company that holds an IRA.
Let's be honest. The first $100,000 is the hardest $100,000 to save.
If you cash out work-based retirement plans every time you change jobs, even if it's only $10,000 or $20,000, you'll always be starting over and never build the kind of financial security you need.
Smart move 5. Don't mistake your IRA for an emergency fund.
If you're making regular contributions and rolling old 401(k) plans into your IRA, it won't take long before it becomes the single biggest asset you have.
The temptation to use that money for something else can be strong. I'll just borrow a little, you think. I'll pay it all back later.
In most cases, this is the opposite of a smart move.
"Probably the biggest mistake is taking money out of an IRA as an early distribution without realizing just how much it's going to cost in taxes and penalties," says Erin Baehr, a certified financial planner who heads Baehr Family Financial in Stroudsburg, Pennsylvania.
You can take money out of a traditional IRA without incurring any costs, under what is called a "tax-free rollover," if you return it to the same IRA or a new one within 60 days.
But if you go past that brief window, you'll not only owe taxes on the money, everyone younger than 59½ will also owe a 10% penalty.
The IRA is very strict about the rules. The 60 days begin the day you get the money. You also can only take advantage of the provision once a year, and even if you have two or three IRAs, you can only use the rollover once.
You can also generally take money out of your IRAs for a first-time home purchase or certain medical and educational expenses without penalty. But if it's a traditional IRA, you'll still have pay taxes on the withdrawal, which can significantly boost your tax bill.
The rules are different for a Roth IRA, where you can withdraw contributions — but not earnings — tax-free because you've already paid taxes on the money.
But just because you can do something doesn't mean you should.
Taking money out of a retirement plan means you lose the opportunity for it to grow and make you richer down the road.