How to Open an IRA in Six Simple Steps

An individual retirement account, or IRA for short, is a tax-advantaged option to save for retirement. IRAs come in many flavors - traditional, Roth, SEP, SIMPLE, non-deductible, spousal, and self-directed. Each solution comes with specific rules regarding taxation, eligibility, and withdrawal policies. Depending on the account type you opt for, you could benefit from tax-deductible contributions or tax-free withdrawals.

Also referred to as individual retirement arrangements, IRAs are available from banks, robo advisors, brokers, and similar financial institutions. If this account type sounds like a good fit for your retirement plans, keep reading this article.

Choose an Investing Approach

Before you can open an IRA, you need to think about the overall investment approach you’d like to employ. In other words, the first step is deciding how much help you want on your retirement investment journey. Opting for a hands-on or hands-off investing style will determine whether you should open an account with an online broker or a robo advisor.

If you’d like to be involved in choosing and managing your investments, we recommend you do so with the help of an online broker. Choosing a hands-on approach allows you to make investments yourself over time.

If you prefer a more automated way, we propose you consider robo-advisory services. A robo advisor will pick out low-cost funds and periodically rebalance your portfolio, ensuring that it stays within your investment preferences and timeline. It does this for a fraction of the fee that a human financial advisor charges.

Decide Where to Open Your IRA

The financial institution that holds your IRA is referred to as the custodian because it takes custody of your money. Once you’re done defining your investment style, it’s time to find a provider which fits your preferences. Nearly every investment company offers IRAs, which makes for a broad selection.

Before you make the decision, make sure to ask yourself the following questions:

• Are there any opening or maintenance fees?
• Are there account minimums or investment minimums?
• Does the company provide customer support online or by phone?
• Does the provider offer the investment types you're looking for, such as stocks, bonds, ETFs, actively managed funds, or target-date funds?
• What are the costs of trading? The answer to this question is especially important if you plan to buy and sell securities frequently.

If you are a hands-on investor

No matter if you’re a beginner investor or you already have some trading experience, we recommend setting up an IRA with a broker that charges small commissions and imposes low or no account fees.

We also suggest you look for a provider that offers a good selection of commission-free ETFs and no-transaction-fee mutual funds. If you’re new to the investment, make sure to choose a company that offers multi-channel customer support and a comprehensive library of educational resources.

If you are a hand-off investor

Automated investment management is an excellent option for those who’d like to avoid agonizing investment decisions. We suggest starting an IRA with a robo advisor that charges a low management fee (0.40% or less) and offers all the services that meet your needs.

Note that portfolio allocation and automatic rebalancing are usually standard, while things like goal planning, tax-loss harvesting, borrowing against your portfolio, and access to a human financial advisor can vary by provider.

Choose an Account Type

IRAs come in several flavors. Factors like your income, age, and possible tax consequences play an important role in determining a suitable account option for your needs. Here’s an overview of the most popular types:

Traditional IRA

This is the most popular solution among individual tax-advantaged retirement savings accounts. It’s designed for workers who don’t have access to an employer-sponsored retirement plan and investors with high-paying jobs who believe they’re in a higher tax bracket ahead of their retirement years.

A traditional IRA offers an upfront tax break of up to $6,000 in 2021, along with an additional $1,000 catch-up contribution for those aged 50 or above. Contributions may be partially or fully deductible, thus lowering your taxable income for the year. Still, this depends on several factors, including your filing status, income level, and whether you or your spouse have a workplace-sponsored retirement plan.

Investment earnings that accumulate in traditional IRAs won’t be taxed as long as the money remains in the protection of the account. However, when you start making withdrawals during retirement, you’ll have to pay income taxes.

Roth IRA

The annual contribution limits for both traditional and Roth IRAs are the same. In 2024, the IRS capped them at $7,000, although account holders who are at least 50 years old can benefit from a slightly higher limit of $8,000. When it comes to taxes, IRA contributions to Roth and traditional accounts are treated completely differently.

Roth IRA holders make contributions in the money they have already paid taxes on. In other words, given that the account is funded with after-tax dollars, assets you keep in this IRA type grow tax-free. But while your withdrawals in retirement will be completely tax-free, you won’t get to deduct contributions from your income in the present.

Overall, taking advantage of tax-free withdrawals granted by the Roth IRA type is a smart move for retirement savers who predict that they’ll find themselves in a higher tax bracket later on. Bear in mind that withdrawals from Roth IRAs before the age of 59½ are subject to a 10% early withdrawal penalty.

SEP IRA

While traditional and Roth IRAs are by far the most popular options, there are several other solutions to choose from. A simplified employee pension IRA is a type of traditional investment account that is set up and funded for employees by their employer. The employer gets tax benefits, and account earnings grow tax-free.

According to the IRS, annual SEP contribution limits are much higher than those imposed by other tax-favored retirement accounts - the first limit of up to 25% of the employee’s compensation or up to $69,000 in 2024.

Note that while the size of SEP IRA account contributions may vary from year to year based on the company’s cash flow, they must always be distributed equally (on a percentage basis of the salary) to all eligible workers.

It’s also important to mention that sole proprietors can open a simplified employee pension IRA for themselves.

In conclusion, this type of tax-advantaged retirement account is a great solution for small business owners who’d like to avoid the cost of starting a conventional retirement plan but get tax deductions on contributions made for employees and supersize their retirement nest egg.

Non-deductible IRA

By now, you probably know that contributions made to individual retirement accounts may be tax-deductible. However, if you or your spouse have an employer-sponsored retirement plan and your income goes beyond the IRA income limits, you probably won’t be able to deduct your contributions on a traditional IRA.

This doesn’t mean that you cannot still put money into an individual retirement account.

As its name suggests, a non-deductible IRA lets you make contributions with after-tax income, which isn’t deductible. However, on a more positive note, you still get the advantage of tax-deferred growth with this account type. In retirement, you’ll have to pay taxes on any earnings growth you take out; however, not on the principal as your IRA contribution was already taxed.

Overall, given that this type lacks some of the main benefits offered by the traditional or Roth solutions, we suggest you open this account type only if you can’t contribute to the aforementioned options.

Spousal IRA

Rules imposed by the IRS clearly state that individuals must have an income to be eligible to contribute to an IRA. However, the regulations are not that strict when it comes to married taxpayers. If one-half of the pair isn’t working - or earns very low income - both can still contribute to their own separate Roth or traditional IRA accounts.

To qualify, couples must file a joint tax return and have taxable compensation.

Contribution limits mirror those set for a traditional or Roth IRA, both for the working and the non-working spouse. Note that the amount contributed to the individual retirement accounts has to be the lesser of double the annual IRA contribution limit or their joint taxable income.

While the account can be funded with the money earned by either spouse, it must be opened in the non-working spouse’s name.

In short, a spousal IRA is a great solution for non-working or low-income individuals who are married to someone with a higher income.

SIMPLE IRA

Sharing many similarities with employer-sponsored 401(k) plans, a savings incentive match plan for employees or SIMPLE IRA is primarily used by small-business owners and the self-employed.

The main difference between a SEP and a SIMPLE IRA is that the latter lets employees contribute to the account via salary deferral. Depending on the plan, workers may even be allowed to open an account with a financial institution they choose themselves.

As far as taxes go, the rules are the same as those applied to traditional IRAs. Still, there are a few more considerations to keep in mind. If you compare a SIMPLE IRA to a 401k plan, you’ll see that the annual contribution limit is set lower for an individual retirement account - $13,500 vs. $19,500 in 2021.

To be eligible for a SIMPLE IRA, an employee needs to have earned at least $5,000 throughout any prior two years and be certain that they’ll receive at least that same amount in the current calendar year. It’s also good to know that account holders can roll the funds into a traditional IRA account after completing two years of participation in the SIMPLE IRA plan.

To conclude, SIMPLE IRAs best fit companies with up to 100 employees. If you’re self-employed or run a smaller company, we suggest you consider opting for a SEP IRA for the higher contribution limits.

Self-Directed IRA

Lastly, there are the self-directed IRAs. These accounts are governed by the same qualification and contribution regulations as the traditional and Roth options. So, what is it that makes them different? A self-directed IRA is unique in terms of what goes into the account.

All the other IRA flavors we’ve discussed in this article typically limit investment options to the most common tradable financial asset such as stocks, bonds, ETFs, and mutual funds.

But a self-directed IRA also lets you keep real estate, privately held companies, and hard assets such as gold in your portfolio. However, the IRS won’t let you keep your life insurance of any type of collectibles in your self-directed IRA.

While this IRA type may seem like the simplest and the most flexible account type, it may prove to be quite the contrary. Keep in mind that setting up a self-directed IRA requires a custodian or a trustee who specializes in the unusual types of investments that you may be interested in.

Admittedly, a self-directed IRA is a good choice for experienced investors who’d like to be exposed to more unique types of securities such as non-traditional businesses and real estate.

Although there are many benefits to opening an IRA of this type before you do so, make sure to familiarize yourself with all the potential risks, such as potential taxes and penalties.

Open an Account

Once you’ve decided on the right provider and account type, it’s time to fill out the paperwork and officially open your account. Although the actual steps may vary a little depending on the provider, the process of opening an IRA is relatively fast and simple.

Most banks and brokerage companies have web pages where you can choose the desired account type and set up an IRA. Depending on the service provider and your preference, you should be able to complete the application process or finish the procedure with the help of a customer support representative.

As far as paperwork goes, you’ll probably need the following:

• Your driver’s license or another government-issued photo identification document
• Your Social Security number
• The number of your checking or savings account and your bank’s routing number for money transfers
• Your employer’s name and address
• The name, address, and Social Security number of your plan beneficiary (the individual who will receive the money in your IRA account if you die)
• Fund Your Account

Now that you’ve learned how to open an IRA, the next step you should familiarize yourself with is funding the retirement account. Note that this step can be completed in a few different ways - you can fund your account by making a deposit from a bank account, transferring existing IRA assets held with a different provider to your new account, or by rolling over a 401(k).

If you choose to fund your account from a bank or brokerage, you’ll just need your account number and routing number. We also advise you to set up automatic transfers for future contributions, especially if you are just starting out. Just keep in mind that IRAs have annual contribution limits.

Investors with a 401(k) from an old job have the option to either move those funds into their new employer’s retirement plan or an individual retirement account. Most people opt for rolling over into an IRA as these account types offer a wider range of investment choices and impose lower fees than many 401(k)s.

While rolling over a 401(k) is a little more complicated than making a transfer from your bank account, there’s nothing to worry about, as most IRA providers have rollover specialists on staff. To sum up, the procedure consists of getting in touch with the plan administrator at your former workplace and completing a few forms.

Choose Your Investments

The last step involves creating your portfolio. If you’ve chosen the hands-off route and wish to use a robo advisor, you won’t need to handpick your investments. Your robo-advisory platform will ask you to set your goals and preferences. Using this data, the software will select the most suitable investments and even adjust them with time.

If you decide to pick your traditional or Roth IRA investment options with the help of an online broker, we suggest you start with ETFs and low-cost index funds. That way, not only will you achieve maximum portfolio diversity and lower your investing risks, but you’ll also minimize the fees you’ll need.