Opening an IRA is a logical choice for those without a 401(k) or similar workplace account to store their retirement money. IRAs offer tax incentives that make them an attractive place to park money.
[See: 10 Steps to Max Out Your IRA.]
However, not all IRAs are the same. There can be vast differences in their tax benefits, investment options and growth potential. "It's probably the most complicated financial product we have," says Nancy Coutu, co-founder and principal of Money Managers Advisory in Oak Brook, Illinois. According to finance experts, there are three components to finding a great IRA.
Select the right type of IRA. Christian Cordoba, a personal wealth manager with California Retirement Advisors in El Segundo, California, says you can break IRAs down into 10 different types. These include the myRA, offered by the government, as well as specialized products such as SIMPLE and SEP IRAs that are set up through a workplace. However, for most people, the decision comes down to either a traditional IRA or a Roth IRA.
Contributions to traditional IRAs are tax-deductible at the time of their deposit. Then, money withdrawn in retirement is subject to income taxes. With a Roth IRA, a worker pays taxes on the money in the year of the contribution, but withdrawals are tax-free. With either option, workers must wait until age 59 ½, with certain exceptions, to withdraw money or be subject to a 10 percent tax penalty on part or all of the distribution. "It really boils down to whether you want to pay taxes now or pay taxes later," says Ron Brown, president of R.L. Brown Wealth Management in Lexington, Kentucky.
Look for the proper custodian. Once someone has settled on the type of IRA, the next decision is which custodian to use. "The custodian is where the game is played so to speak," Cordoba says. There are four major categories of IRA custodians. These include:
-- Mutual fund companies
-- Insurance companies
-- Brokerage firms
The type of custodian plays a role in which investments are provided for the IRA. For example, IRAs offered by insurance companies may hold annuities, and IRAs at banks are known to offer certificates of deposit. Mutual fund companies may allow people to put money into stocks, bonds or exchange-traded funds. Brokerage firms offer a variety of options at different price points.
Choosing the right custodian often boils down to which options people want for their money. Those close to retirement who worry about market losses might find peace of mind with IRAs offered by banks that provide relatively safe investments, while those seeking a simple option with guaranteed income may find an IRA with an annuity puts their savings on autopilot.
For those who want to put their money in the market, Coutu suggests people look for no-load investments, which are sold without any commission or sales charge. "The benefit of a brokerage account is you have multiple no-load options," she says.
Pick the right funds. At some custodians, there are limited investment options, but those at mutual fund and brokerage firms usually have a variety of choices available. The right option depends largely on how many years a person has until retirement.
Those planning to retire within five to 10 years may want to shift to a more conservative strategy. "The next best thing to making money is not losing it," Coutu says. Those with a longer time horizon can afford to be more aggressive.
Cordoba says the amount of money in the IRA can also play a role in determining the right fund choice. "If there are less dollars [in the IRA], you can afford to be more aggressive with them," since less money means less to lose.
However, Brown recommends that rather than trying to guess the right fund strategy, investors consult with a professional. Not only can a financial advisor help people find a great IRA, but they can also help determine the best way to minimize taxes when cashing out. Brown says financial advice comes at a price, but it can be money well-spent. "You can avoid costly mistakes with proper planning."
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