23 July 2007 7 Comments Print This Post  Email This Post

So I finally got around to opening up an IRA, an individual retirement account. Like most younger people, I just didn’t really know where to go and how to get started. I asked myself what’s a roth IRA and how is it different than a traditional IRA? Which is better? Why do I even need one? What the heck is it?

IRAs 101 

Basically an IRA is an account where the US government allows individual investors to save money for retirement. The money you contribute into the account is limited by the federal government and works on a use it or lose it arrangement. If you don’t contribute one year, you can’t double up on the next year. This is why you need one ASAP if you don’t already have one and fully fund it. The Roth IRA came into existence in 1997 by the taxpayer’s relief act. Here are the key features of the traditional IRA and the roth IRA:

Traditional IRA

• Can be used to invest in a varierty of investments.
• You can withdraw at age 59 1/2 and you are required to withdraw by age 70 1/2.
• The money you contribute is tax deductable, based on your income level.
• All capital gains from your investments are taxed at your tax rate when you withdraw.
• No income restrictions.
• Assets can be used to purchase a home, college costs or major medical expenses.

Roth IRA

• Contributions are made with after-tax dollars. You can’t deduct contributions.
• No mandatory distribution age.
• All gains are tax-free!
• Can be used to invest in a variety of investments.
• Certain income restrictions apply.

My Choice

I went with a Roth IRA. I’m not making tons of money right now so the taxes I save from the deductions would be slim. Also, because I’m starting young I expect a lot of capital gains from my investments, which I would like to be tax free. Lastly, I figure at the time I start withdrawing funds, I’ll be making a lot more money than I do now, including real estate rental income and income from businesses, so I would hate to be taxed at a high bracket.

How to open an IRA

Basically many financial institutions offer IRAs. I’m sure you can walk into a bank and set one up on the spot. I chose to go with ETRADE. I guess I like the convenience of online access and the ability to set it up online. I also have my normal brokerage account there too so it makes life much easier if I had the IRA there too.  ETRADE has a very strait forward process. I researched IRAs on their site, and opened up a Roth IRA in about 10 minutes. They also have many great tools and features as well for the everyday investor.

Do It Now! 

Seriously, if you don’t have one, set one up immediately. Look at the graph above. That shows the difference that a 10 year delay can make on your retirement account. You’ll have a lot more saved up the younger you start because the power of compounding interest does wonders, especially in the later years when the numbers are bigger. I’m glad to have finally opened one up. I’m funding it tomorrow with the full $4000 limit.