Tax planning and compliance for investors
Free Online Guides
Kaye A. Thomas
Updated April 9, 2011
If you don't know how to get started, this page will take you through the process step by step.
Starting a Roth IRA isn't difficult. Any number of providers are more than happy to make this process easy for you. This page covers both the thought process you should go through and the practical steps you need to take.
To start a Roth IRA you need to take the following steps:
It's your responsibility — not the IRA provider's — to determine that you're eligible to establish a Roth IRA. And there's no point in setting one up if you'll merely have to undo the process later. Most people with earned income and "modified adjusted gross income" below applicable limits are eligible to contribute to a Roth IRA. See Regular Contributions to Roth IRAs. To determine whether you can make a conversion to a Roth IRA, visit Roth IRA Conversion Eligibility.
This site provides extensive guidance on choosing between the Roth IRA and other investment vehicles. If you're unsure about this choice, at a minimum you should read the following pages:
If you want more details you can read other pages under the heading "To Roth or Not to Roth" in our Guide to Roth Accounts.
The best type of investment for your Roth IRA depends on various factors:
The tax law doesn't set a minimum size for a Roth IRA, but providers generally set minimum account sizes. If one provider won't accept your account because it's too small, try another. In any event, if you're starting small, it makes sense to choose a simple investment that won't incur a lot of fees or require a lot of attention. You can get fancy after you've built your IRA to a larger size.
When investing for the long term it makes sense to take some risk to obtain higher rewards. If the risk produces losses, you'll have plenty of time to recover. Short term investors need to put more emphasis on asset protection.
If you have other savings, such as a brokerage account or a 401k account, consider whether your IRA can be invested in a way that provides more balance to your overall portfolio. Another consideration is the allocation of assets between taxable accounts and non-taxable accounts. For example, some advisors suggest keeping assets that produce mostly ordinary income (like interest or dividends that don't qualify for the 15% rate) in an IRA or other non-taxable account, and investing your taxable accounts in assets that produce long-term capital gain or qualifying dividends.
Choose an investment you're comfortable with. Some investors are willing to risk losses in order to have a shot at higher gains. Others are willing to accept a lower return to get a greater feeling of security.
Investing style affects your choice in another way. Some types of investments do quite well if you ignore them for extended periods. Others need frequent attention. How much time and effort do you want to put into your IRA investments?
It's easy enough to find an IRA provider. But which one is best for you?
For this purpose, "banks" include trust companies, savings and loans, and credit unions as well as commercial banks. They often accept relatively small accounts and may charge minimal fees or no fee at all, making them an attractive choice for people who want to start out small. But they'll gladly accept larger accounts! A bank isn't likely to offer as many investment alternatives as a mutual fund company or brokerage firm, however.
Mutual fund companies can provide a wide range of investments. You may be able to invest parts of your IRA in different types of funds, achieving the mix that's right for you. Some mutual fund companies make it easy to shift some or all of your IRA from one fund to another when your investment objectives change. Many investors will find that this is the best choice.
Many brokerage firms offer IRA accounts. These give you the ability to make specific investments for your IRA. Want to design your own portfolio? If so, open an IRA with a brokerage firm. Many brokers make it possible to own mutual fund shares as well as individual stocks.
Insurance companies provide IRAs, too. This choice may be appealing if you want to invest your IRA in an annuity or you find some other investment offering of the insurance company attractive. Be sure to obtain unbiased advice before buying an annuity — in other words, advice from someone other than an agent or advisor who will earn a commission on the sale.
Before you settle on a particular provider, ask about the fees that will apply to your account. There may be startup fees, annual maintenance fees, fees for changing your investments or withdrawing your money. These fees can have a significant impact on the investment performance of your IRA. It's especially important to know what would be involved if you decide you want to transfer your account to another provider.
Establishing your IRA can be a simple as walking into a bank or brokerage office, filling out a few forms (make sure you have your social security number!) and writing a check. You can also set up an IRA over the Internet if the provider you prefer does business that way. There are a few points to keep in mind when you establish your account.
You're permitted to determine who receives your IRA at your death. Chances are the form presented to you by the IRA provider will say it goes to your spouse, if you have a living spouse at your death, and otherwise goes to your estate. This isn't necessarily the best choice. If you're putting a substantial amount into your IRA, it may make sense to consult an estate planning professional. And don't forget you can name a contingent beneficiary in case the first beneficiary dies before you do.
Finally there's the little matter of record keeping. Make sure you have a safe place for all records pertaining to your IRA, where you'll be able to get at them when it's time to fill out your income tax return or make a change in your investments. You aren't required to report regular contributions to a Roth IRA, however, unless you also took distributions from your Roth IRA.
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