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Everything you need to know about opening a Roth IRA, from eligibility to investments.

Introduction

Opening a Roth IRA can be one of the best retirement-planning decisions you make, because your money grows tax-free and you can withdraw it tax-free when you retire. To start a Roth IRA isn’t nearly as hard as it seems. Some of the most common questions  are:

Let’s address each in turn.

Are you eligible for a Roth IRA?

Your eligibility for a Roth IRA may be limited by your income. If you earn too much, you may not be able to contribute. The chart below shows the limits for 2017.

For 2017, you can contribute $5,500, in total, to all your IRAs. You can contribute $6,500 if you are 50 or older. The contribution limits for IRAs typically change every year.

If your filing status isAnd your modified AGI is …Then you can contribute ...
Married filing jointly< $186,000up to the limit
>$186,000 but <$196,000a reduced amount
> $196,000zero
Married filing separately, but you live with your spouse<$10,000a reduced amount
>$10,000zero
Single, head of household, or married filing separately and you did not live with your spouse at any time during the year

 

<$118,000up to the limit
>$118,000 but <$133,000a reduced amount
>  $133,000zero

If you must reduce your contribution based on the chart above,  you can find the formula for figuring how much you can contribute here, on the IRS website.

If you make too much to contribute directly to a Roth IRA, you may be able to do a “backdoor” Roth IRA conversion.

What is the deadline for opening a Roth IRA?

The deadline for opening a Roth IRA account and making contributions is generally April 15 of the following tax year. This date is sometimes later, due to weekends or holidays. For instance, the deadline to make contributions for the 2017 tax year is April 18, 2018.

Where should you open a Roth IRA?

It’s difficult these days to find a bank, discount broker or mutual fund company that doesn’t offer the option to open and access a Roth IRA account online. If you have access to a computer and a basic level of Internet skill, this is unquestionably the way to go. If you don’t, you’ll need to head to your local bank branch or brokerage firm and sign up in person (how decidedly 20th-century of you).

Given the many advantages—in time, convenience and fees—of working with online banks and brokerages, we’ll focus on that approach. The number of institutions offering online access is far too big to list, but you likely already know the names of some of the bigger names: brokerage firms such as Schwab and TD Ameritrade, mutual funds such as Fidelity and Vanguard; and banks such as Bank of America and Wells Fargo. If one of the big firms isn’t in your town, your local bank most likely offers retirement accounts. Given their size, however, their online offerings may be more limited and their fees may be higher.

Then there are the exclusively online entities, like

  • E*Trade, a discount brokerage, that offers very low trading fees and access to many different investment products.
  • Merrill Edge, which has a connection with a bank—Bank of America—which can make regular automatic transfers into your Roth IRA easy. It also offers low-cost trades and the ability to work with financial advisors.

If you have an existing Traditional IRA somewhere, the same firm can probably open a Roth IRA for you.

Most experts suggest asking these questions when you consider a home for your account:

  • What kind of customer service does it offer, whether it is online or by telephone?
  • Does it offer the kinds of investments you want, from ETFs to target-date funds to actively managed funds?
  • How much does it cost to make a trade (especially if you plan to buy and sell frequently in your account)?
  • Is there a fee to open or maintain the account?

And speaking of the latter…

Avoiding fees

Repeat after me: I will not pay high fees.

Now say it again.

You have enough to worry about when choosing where to put your money to work to get a good return. Don’t make it even more difficult by signing up for an account that charges you a lot of money simply for the privilege of having an account.

Other than investing all your money into a company that is developing a better VCR, paying high fees is a sure-fire way to lower your returns. Paying some fees is inevitable; it’s one of the ways a financial institution makes money. Some, however, are greedier than others.

Fees come in many forms: account maintenance, transaction, trading, low account balance, inactivity, and many others. If a bank, mutual fund or brokerage can think of a fee, they’re likely to charge it. To minimize them, you first have to get a sense of what type of account holder you’re likely to be. Which leads us to…

How do you choose your investments?

Making the decision to open a Roth IRA is just the first step toward a secure financial future. After you open an account, you will need to decide what sort of assets you want it to hold, Things to ask yourself:

  • Are you likely to do a lot of trading of individual stocks and bonds?
  • Are you more of a buy-and-hold investor?
  • Are you going to invest in mutual funds or exchange-traded funds?
  • Do you only have a small amount of money to invest?
  • Do you want help picking investments, or are you comfortable making your own decisions?
  • Do you tend to use investment research to guide your decisions?

Depending on the answers, you can put yourself in one or more of the following categories, each with their own rules for avoiding fees.

Sophisticated, active investor: Go for an account with low per-trade fees. Some firms will even lower trading fees after a certain number per month, quarter or year, and will offer free access to proprietary research.

Buy-and-holder: Avoid accounts with high inactivity fees.

Mutual fund investor: You’ll want to pay particular attention to the fees charged by the individual funds that you invest in (these may be different than more general, administrative fees that your brokerage firm will charge for holding any type of retirement account). Mutual fund fees include account management, exchange, redemption and so-called 12b-1 fees. Account maintenance, management and 12b-1 fees are important regardless of whether you actively move in and out of different mutual funds. Mutual fund companies charge these fees to all investors to cover the cost of picking investments, marketing the fund, and general administration. You may pay exchange or redemption fees when you switch your money from one fund to another within the same fund company or when you sell your shares. These fees are most significant if you plan to move in and out of funds with some regularity. Sites such as www.morningstar.com can help you choose a low-fee fund that’s right for you.

The hand-holder: If you’d like help from a professional in setting up and managing your retirement account, be prepared to pay for it. The ideal is to find a good financial advisor who charges by the hour or a flat annual fee to manage your account. Those who get commissions based on your trading activity have an incentive to “churn” your assets; in other words, they get paid by how actively they invest, rather than how well. Other firms charge an annual management fee, often one percent of the amount in the account. It’s only worth it if, over time, the manager’s returns exceed market averages by more than one percent. Otherwise, you may want to just invest in low-cost stock and bond index funds that mimic overall market performance—rather than trying to beat it.

 Three types of investments to consider

There are three primary types of investments that should be available from your Roth IRA provider:

  • Investments in the stock market
  • Investments in the bond market
  • Other income-generating investments

The list above is ranked from most risky to least risky. If you stick your entire portfolio into a CD then you’ll get a low return, but your risk will be really low as well. The more risk you take on, generally speaking, the more return you earn. That’s why investments in stocks have historically paid higher returns. Bonds fall somewhere in between stocks and CDs.

Mutual funds in the marketplace are run by professional investors that spend all day long analyzing the holdings of their particular fund. They’re all over any news that is coming out, and they’re dedicated to making the fund money all the time. By stepping out of the mutual fund realm and selecting individual stocks and bonds to invest in you are taking an enormous risk. Granted, with great risk can come great reward. The stock you choose could double in the course of a week. On the other hand it could drop to 20% of its value, or your individual bond borrower may go bankrupt. Mutual funds are a much safer bet for a majority of investors that don’t have the time to constantly be researching individual stocks.

For Roth IRAs, Most experts recommend buying two to six different mutual funds or exchange-traded funds, some that focus on stocks and some that have bonds. You should also keep a small portion of your account in cash or cash equivalents, such as money-market funds. Look for funds that have expense ratios of less than 0.5%. Remember: That fee is in addition to the fee you may pay to the bank or brokerage for the account itself.

Another good option is target-date funds or lifecycle funds. These are designed to automatically diversify your investments and adjust over time, so that you have less risk of a large drop in value as you near retirement. Some examples of good fund families are Fidelity’s Freedom Funds or Vanguard’s Target Date Funds. If you buy a target date fund, remember it is designed to hold your entire retirement nest egg. It’s best to buy just one.

Two factors: age and risk comfort

There are two factors that can help guide your investment decisions: your age and your comfort with risk.

Age

As a general rule, the closer you are to retirement age, the less risk you want to assume. If you’re only a few years away from hanging up your day job then you can’t afford a drastic downturn in your portfolio. Likewise, if you are many years from retirement and just starting out in your investing, then you can afford to accept some risk in your investments. Even a prolonged market slump, like the Great Recession that began in 2008, won’t kill your portfolio, because you have a couple of decades to recover those losses.

There are a multitude of methods to determine exactly how much of your portfolio should be in higher-risk investments such as stocks versus how much should be in safer investments like bonds. One popular method is the “120 minus your age” formula. You simply subtract your age from 120. The resulting difference represents the percentage of your portfolio that should be in equities. For example, if you’re 25 you should have 95% of your portfolio in stock investments. If you’re 60 and about to retire you need to scale your investments back to 60% stocks and 40% bonds (or other lower-risk assets).

Comfort Factor

The second factor that determines where you should invest is how comfortable you are with risk. If the thought of putting money into the volatile stock market terrifies you then you’ll need to adjust your portfolio (and perhaps your expectations) accordingly. You can’t, and shouldn’t, abandon equities completely, but you need an approach that you are comfortable with, so you will continue to invest methodically. Forcing yourself to invest against combats this goal (and leads to sleepless nights as well).

Compare Popular IRA Providers

Provider
Fidelity Investments
Merrill Edge
E*Trade
NameFidelity Roth IRAMerrill Edge IRAE*Trade IRA
DescriptionGet a range of investment choices, tax advantages and 1:1 help with a Fidelity Roth IRAGet up to $600 when you invest in a new Merrill Edge IRA. Plus one-on-one guidance, actionable insights and easy-to-use tools. Learn MoreLearn more about an E*TRADE Roth IRA. > Learn More