How to Sign Up For an Individual Retirement Account in 5 Easy Steps

Someone asked me the other day, “I’ve heard a lot about the Individual Retirement Account (IRAs), but I have no idea how to set one up. How can I do it?” I realized that this person had a great question because unless you work in the financial industry or strangely have a hobby of reading tax codes you would have no idea how or why to open an IRA. Let’s look at how you could set one up in no time at all.

Step 1: Check If Your Employer Gives a Matching Contribution to Your Retirement Plan Through Work

Have you ever looked at your 401k benefits at work? You should. You might be leaving guaranteed 100% returns on the table. What I mean by that is most employers, private and public, provide some sort of matching contribution for whatever you put into their retirement plan. Most workplace retirement plans are named after some random 3 figure number that starts with 4, so 401k, 403b, and 457 are prominent examples.

You will need to check with HR to be sure, but a very common match these days is up to 4% of your compensation for every dollar you contribute. Even if you have a horrible retirement plan at work, the match makes participating in the plan worth it. You can always move the assets elsewhere when you change jobs. So first, make sure you are getting 100% of the matching money available through your employer or else you will be leaving loads of free money on the table and that would stink.

Step 2: Figure Out If You Are Eligible and If You Want a Pre or Post Tax IRA

Contribution rules to IRAs are needlessly complicated, and you need to make sure you fall in the right category before choosing one. If you are not covered by a retirement plan at work at all, then you get to deduct the full benefit of a pre-tax IRA on your taxes. I would go with a Traditional IRA in this case if your income is over $45,000 if single or $90,000 if married. The reason is you get a 25% tax savings or more right away, which will allow you to save more right now.

If you already have a retirement plan like a 401k at work and want to save more, you’re awesome. The rules are a little more complicated but easy enough. If you make less than $61,000 as a single person, you get the full tax deduction benefit of an IRA. For married folks, the limit is $98,000 in income a year. For a Roth IRA, you can open one as long as your income is below $116,000 if you are single and $183,000 if you are married. Hence, most people that have a 401k at work will want to open a Roth IRA with extra savings.

So if you have a retirement plan at work already and make less than 45k a Roth IRA is probably best. If you make between 45k – 61k it is a tossup but I would choose the traditional IRA. If you make more than 61k I would choose the Roth IRA. If you make more than $116k, then you are not going to be able to access an IRA the easy way. You will need to do something called a back door IRA contribution. Basically you contribute after tax money to a Traditional IRA and immediately convert it to a Roth IRA. If you want to do this you should speak with a tax adviser.

Step 3: Earn at Least $5,500 in Taxable Wages To Take Advantage of the Full Contribution

To fund an IRA, you must earn taxable wages. This requirement exists to prevent wealthy parents from funding an IRA for junior when he is 1 year old. An IRA is in your name and the IRS expects to see earned income on your tax return in order to allow your contributions and not tax them.

If you work part time over the summer you can still put money into an IRA but only to the extent that you have wages. The max contribution for 2015 is $5,500 a year, so you can contribute any number between 0 and $5,500 as long as you have that same amount of income or more. In other words someone who worked at a law office during summer in college and made $3,000 could contribute $3,000 to an IRA. A worker who made $50,000 could contribute only $5,500 however because it is the max. This is a relatively easy requirement for most people, but I messed it up one time so I figured that it is important to point out that you must have actual wages to start an IRA.

Step 4: Pick a Financial Institution

You have checked to see if your workplace retirement account gives a match, and you figured out that either an IRA is a better option or you have extra money to set aside for retirement. You have decided between a Traditional and Roth IRA because of your income status for this year, and you earn more than $5,500 in income. Now all you have to do is decide what phone number you will call or website you will search.

I think Vanguard is the best option for the average person who would be reading this article who wants to set up an IRA. You can call 877-662-7447 and speak to a call center person who can easily walk you through setting one up. They will not give tax advice so you should make the pre or post tax IRA decision before you call, and they can help with the rest. I recommend Vanguard because they are the cheapest, and in investing what matters is how little you get charged to invest. Another option if you do not want to do investing on your own is Wealthfront or Betterment. They will charge you 0.15%-0.25% in addition to the low cost ETF fees in their portfolio, for a total fee of 0.25%-0.4%. To be honest though, this is investing not rocket science. I would keep things as simple as possible and just call Vanguard. Schwab is another alternative with low cost funds if you already have an account there. Just be aware that in addition to their great low cost index funds they might try and sell you advice that you do not need.

Step 5: Pick Your Investments

Once you choose a financial institution you can pick your investments. The best simple option I can think of is the Target Retirement Funds at Vanguard. All you need is one fund. It has all the diversification you could need in a simple one fund solution. All you do is call Vanguard and put your $5,500 contribution into the Target Retirement Fund closest to your expected retirement year. I would choose a later one even if you are thinking of retiring early just because it will have more aggressive stock percentages, and bonds are horrible right now. The reason you can invest in one fund and be done is because that fund has a bunch of other funds within it.

Target retirement funds are a unique invention in personal finance. You get holdings in thousands of different stocks and bonds in one fund at an annual fee of around 0.16% to 0.18% of your total investment. Compare that fee to a typical actively managed mutual fund fee of 1% or more and you will realize why that fund is such a great option. Check out VFFVX, the Vanguard Target Retirement Fund 2055, in Google Search and you will see what I mean. The only big difference between the different funds is the mix of stocks and bonds so you only need one. I have seen people choose 5 different target retirement funds and believe that they are more diversified. That is silly and pointless, just select a fund that has an aggressive enough allocation, probably anything 2040 and later. Look under the hood of this Target Retirement series and see the low cost mutual funds held within it. If all you do is invest in this one fund for years you will become very wealthy over time. Once you have enough money to justify the use of a financial adviser you can change things around later if you feel like you want a more customized approach as you approach retirement.

What Are You Waiting For? Open Your Individual Retirement Account Today

That’s it! Contribute through your employer up to the amount they will match, and if they don’t match or you have money left over, start an IRA. First figure out if you want the pre or post tax IRA, check to see if your income qualifies, pick a financial institution, and pick your investments. For folks not looking to do investing professionally, I think Vanguard’s Target Retirement Funds are an excellent choice. Call that 877-662-7447 number above and the Vanguard employees will walk you through it. Choose 1 fund and you’re done. Starting an IRA is one of the smartest moves you can do in your 20s. Luckily, any mistakes you make in selecting investments can be minimized because you can move money into and out of investments once they are inside an IRA account. You should not be scared of being locked into the wrong fund or stock because of this flexibility. If I was a betting man, I would say annual IRA contributions starting in your 20s will make you a millionaire by the time you retire. Congrats on reading this article and getting started sooner than 90% of your peers.

*Full disclosure, I did not receive any compensation of any kind for the recommendations in this article.