What is a Roth IRA?
Roth IRA stands for Roth Investment Retirement Account. As the name suggests, it is an account meant for your retirement. You invest money through that account to build a corpus which can be used once you are not working. Investment areas can be stocks, bonds, or mutual funds. You may be wondering if the Roth IRA account is any different than simply investing your money in a mutual fund. The main differentiator between a normal investment and a Roth IRA investment is the tax. While you pay capital gains tax on any investment that you normally make, the Roth IRA account is tax-free when you withdraw the money post your retirement.
It does not matter whether you have a 401(k) plan or not from your workplace. You can still open a Roth IRA account. If the company matches your contribution, then that is even better. But, Roth IRA is something which is independent of any 401(k) plan which your employer might be offering to you. The only thing that connects the two is tax treatment. You might not get the full deduction if you are investing in both 401(k) and a Roth IRA. The big advantage of investing in a Roth IRA is that you have a wider variety of investment choices as compared to a 401(k) plan. You can invest to get a return similar to the stock market or maybe better. In the long run, this marginally better return can result in thousands of dollars of extra corpus.
Opening a Roth IRA account
Opening a Roth IRA account is quite simple, and it can take as little as 20 minutes. You can even do it online. You will need your personal information, birth date, and social security information for opening an IRA account. There are many online brokerage companies that offer a Roth IRA account.
Types of Roth accounts
There are two approaches when opening a Roth IRA with brokerages. First is active management where you select the funds that you want to invest in. Second is passive management where you the service provider build a portfolio for you. As you may have guessed, the first option does not involve any service fee or management fee (only a per trade flat fee is charged when you buy/sell something), while the latter involves a fee. This fee depends on whether you work with a robo-advisor or a human advisor. Robo-advisors are cheaper with a fee ranging from 0.25% to 0.5% in most cases, while human wealth management and portfolio advisors can have varying amounts of fees that depends on a case-to-case basis.
After setting up the account
Once you have figured out what type of Roth IRA account you plan to open, the next step is to make a contribution to the newly opened IRA account. If you are going to be actively managing your portfolio, you have to select mutual funds, bonds, or stocks that you want to invest in. Stocks and equity mutual funds are riskier asset classes than bonds and debt. So, your asset allocation will have to match your risk profile.
The online brokerage or service that you are working with should have some tools that will allow you to make these kinds of decisions. Fund screeners, performance data, expense ratios, etc. should be available to you as well.
Remember to always prioritize your 401(k) plan first, especially if your company is matching your contributions. Maximize that first and then think about Roth IRA contribution. And also make sure that you do not go over the Roth IRA limit, because you may incur a penalty for doing so.
Can I withdraw my IRA account money before I retire?
The short answer is yes, you can withdraw money from your IRA Roth account before you retire. You have already paid taxes on the money which you contributed, as it was counted as your income and you would have filed your income taxes. So, there is no burden of tax when you prematurely withdraw funds from your Roth IRA. However, you will have to pay a penalty for early withdrawal. The amount of penalty is decided by various factors including your age during the withdrawal period. Normally, one can expect to pay around 10% for early withdrawal.
Is there a limit on how much one can contribute to a Roth IRA account?
Yes, you can contribute up to $5,500 a year. This limit is applicable to both a Roth IRA and a traditional IRA account and it is a shared limit. So, it is up to you to figure out how much you want to split between the two if you have a traditional and a Roth IRA account. If you are over 50 years, then your limit for IRA account contribution is slightly higher at $6,500.
Benefits of a Roth IRA account
The benefits of having a Roth IRA account are:
You are investing after-tax income and letting it grow over time, setting up a healthy and sizeable corpus for your retirement. It is considered good financial planning
You are not paying taxes in your retirement or old age. You are paying taxes today and locking that tax rate. If tax rates go up in the future, then you will have gained and benefited from a lower rate today.
If you are looking for tax deductions, go for a traditional IRA account. It will give you deductions that you can claim while filing your taxes, but you will have to pay tax when you withdraw it after a few decades or years.
Roth IRA allows your hard earned income to grow tax-free.
Different options for Roth IRA accounts
Now that you have set up your Roth IRA account and are aware of the basic rules and concepts of this retirement planning system, let us look at some of the top companies offering Roth IRA accounts and the features that they include in their services:
- TD Ameritrade
TD Ameritrade is a popular online brokerage firm based out of Nebraska. It offers a Roth IRA account with no minimum balance condition to open an account. As an added incentive, it gives new account customers $600 of credit. Since Ameritrade is an online brokerage, it already has an established user interface with various tools and data that will help you conduct research on various investment options. It even has an IRA account type selection tool. This tool helps you figure out which type of IRA account you should go for based on your personal situation and preferences.They have a retirement counselor available on the phone to whom you can ask questions about your eligibility and other details of IRA accounts. There are plenty of ETFs and mutual funds that you can purchase without paying any fees. If you plan to purchase stocks, then there is a flat $6.95 fee per trade. TD Ameritrade has a mobile version of their site available, so you can always invest on the go or when you are not in front of a computer.
TD Ameritrade has three different interfaces for different types of investments. Anyone from a beginner to an expert is catered to with Ameritrade. As you can tell, this option is great for people who like to be hands-on with their investments and do trades themselves.
- Ally Invest
Ally Invest is another online “self-invest” type of a trading platform. It is a good option for people who want to actively manage their investments. Like TD Ameritrade, Ally Invest also has no minimum balance requirement to start an account. The company offers various types of retirement accounts such as traditional IRA, Roth IRA, SIMPLE IRA, SEP IRA, etc. Setting up the account does not involve any fee.Ally Invest does not charge any inactivity fee or annual fee. However, if you change your IRA account type from say traditional to Roth or vice versa, there is a $50 conversion fee. Trading fees at Ally Invest are low compared to other companies. It charges only $4.95 per trade. If you are a frequent trader (more than 30 times per quarter), that fee goes even lower to $3.95.
If you decide to close your IRA account at Ally Invest, you will have to pay a $50 termination fee and another $50 to transfer the funds out of that account. Fees and charges aside, Ally Invest has a robust platform for researching and investing money. There are many tools to help you make decisions. Like TD Ameritrade, this is a great option for “hands-on” investors. If you are a passive investor, you should look at other options.
Betterment is an online investment advisor which is also known as a “robo-advisor”. It is great for people who want to passively manage their investment without putting in the amount of time that active management requires. Betterment offers traditional IRA, rollover IRA, Roth IRA, SEP IRA, etc. There are plenty of options for every kind of investor.
Robo-advisor basically means using algorithms to optimize an investment strategy without the use of a human financial advisor. As you may imagine, this type of process is substantially less expensive than hiring a financial advisor to work out the asset allocation.There are two plans that Betterment offers. The first is the Digital Level, which has a low fee of 0.35% annual and no minimum balance for balances under $10,000 and 0.25% fee for balances between $10,000 and $99,000. The algorithm at Betterment also balances your investment automatically so that you always maintain a fixed percentage of equity and debt no matter how the market performs.
If you are someone who appreciates the ease of an automatic investment monitoring system but still likes to talk to a human advisor, Betterment has a solution for you. Betterment allows you to answer basic questions via customer service if you are a Digital Level member. The company also offers something known as Premium Level, where you can get detailed advice and support. Charge for Premium Level is 0.4% instead of 0.25% as in the Digital Level. You also need $100,000 to sign up for Premium Level.
Betterment is an excellent option for someone who wants to practice the “invest and forget” principle.
Another passive investor option, Wealthfront is similar to Betterment. It offers the “robo-advisor” model of algorithm-based asset allocation. The good thing about Wealthfront is its fee structure. Unlike Betterment, Wealthfront charges no annual fee for the first $10,000. Once you go beyond that limit, you pay a fee of 0.25%, similar to what Betterment charges.Wealthfront requires a minimum starting balance of $500 to open an account. It offers various types of accounts such as traditional IRA, Roth IRA, rollover and SEP. A unique aspect about Wealthfront is its referral program. It will give you free credit depending upon the number of friends whom you can persuade to join Wealthfront.
Another important part of Wealthfront’s offering is its retirement planning tool. It has an innovative tool that takes into account things like inflation and social security, integrates information from all your accounts across various financial institutions, and gives you insights about your financial life post-retirement. Wealthfront actually has economists who make these projections.
Overall, Wealthfront is a great choice for anyone who is not very finance-oriented or just wants a hands-off approach with useful insights like retirement planning.
Scottrade is a very well-known discount brokerage firm operating out of St. Louis. It is well-known because it has a reputation for providing great customer service. It also offers a broker service if you require the assistance of a broker to make trades or get investment advice. Unlike the robo-advisories, Scottrade has that human touch.However, keep in mind that human capital costs money and you will pay fees for a higher level of human assistance. In fact, fees can run as high as $32 for a broker assisted trade. Normal trade fees for stocks are $6.95, in line with most other online brokerages. Additionally, they offer close to 3100 mutual funds, which you can invest in for no fee. Investors who like to trade at high frequencies will perhaps not find Scottrade very economical, especially since there are other companies offering a lower per trade fee. But people who like to invest in mutual funds or invest for the long term will quite like Scottrade.
One downside about Scottrade is that its online interface is not as savvy and smooth as some of the other companies. There is also a lesser amount of research on the website than what you might find on the website of Scottrade’s competitors.
Overall, Scottrade is great for mutual fund investors and those who place a greater emphasis on a high level of customer service from an actual human being on the other end of the phone line.
E-Trade is a very well-known online trading platform and a financial service firm headquartered in New York. They have one of the biggest brands in the industry and a stellar reputation. Beginner investors will feel the comfort and safety of such a big brand name.E-Trade requires a minimum of $5,000 to open an IRA account though there are some conditions in which the minimum balance can be waived. Advisory fees for managing your portfolio are 0.3%, and you are eligible for a bonus credit depending on the amount that you deposit in your newly opened account.
Various types of IRA accounts are offered, such as traditional IRA, Roth IRA, rollover IRA, etc. Like Ally Invest, e-trade charges $6.95 per stock trade. ETFs are also charged at $6.95 per trade. However, if you make 30 or more trades in a quarter, that fee goes down to $4.95. Higher frequency traders will appreciate the reduced fee per trade.
E-trade does charge a fee on mutual fund trades, unlike some of its competitors. However, it offers you investment opportunities in more than 4,400 funds, which is also more than what any of E-Trade’s competitors seem to be offering.
Overall, E-Trade is a good option for an IRA account. It benefits from having a long established presence in the industry and a recognizable brand name. E-Trade also offers you plenty of investment options over three different platforms, namely E-Trade Web, E-Trade Pro, and Options House. Beginners will appreciate the educational resources that E-Trade has related to retirement planning and stock market basics. The only downside is that you will have to put up with fees and commissions on many of the investment options.
- Charles Schwab
Charles Schwab is another giant of the investment industry. It caters to consumers from all kinds of backgrounds. It offers a trading platform, commission-free ETFs, and more. Warren Buffet often talks about making a portfolio of only index funds. Charles Schwab has no-minimum balance index funds.A minimum of $1,000 is needed to open an IRA account. However, if you are making monthly contributions of $100 or more, then the minimum requirement is waived off. Stock traders will be attracted to Charles Schwab’s low $4.95 fee per trade. This number is less than the standard $6.95 that many online brokerages seem to be charging their customers.
Charles Schwab has more than 250 commission-free ETFs and over 4,000 no-fee mutual funds. The online platform of Charles Schwab allows you to list, sort, and compile a portfolio using various metrics like expense ratios, risk-adjusted returns, and so on. Charles Schwab also offers unparalleled research with reports from Morningstar, CapitalIQ, Market Edge and other well-known research houses. If you like reading about businesses and industries before making your investments, then Charles Schwab will be a treat.
On the customer service front, Charles Schwab has around-the-clock phone customer service on the phone and via the chat window. They also have physical branches across many cities and towns. You can visit one of these branches and speak to a financial advisor or attend workshops. For those who like a passive approach, Charles Schwab also offers a robo-advisory option.
- Merril Edge
Merril Edge is the online brokerage subsidiary of Bank of America. It is a discount brokerage offering competitive pricing to casual traders and long-term investors. The best part of Merrill Edge is that you can access financial advice at more than 2,100 Bank of America locations. Because Bank of America has such a vast and penetrative network, you can actually leverage that network by signing up with its subsidiary.There is no minimum opening balance required and no annual or inactivity charge. Everything works on a per trade basis. Fees are in line with what many other brokerages charge: $6.95 per trade. However, if you open a new account with Merrill Edge, you get 300 ETFs in which you can trade for no commission or fee. If you open a checking account with Bank of America and hold a certain minimum balance in that account, then you get a fixed number of free trades per month. So, there are a few ways in which you can save on the commission and fee costs.
On the research front, Merrill Edge provides you with useful material from the likes of CapitalIQ, Morningstar, and Lipper. Bank of America Merrill Lynch also has its own Global Research arm which provides you with cutting-edge research on mutual funds, stocks, and industry situations.
Though Merrill Edge provides you with plenty of research and advice, it falls short on no-fee mutual funds or ETFs like some of its competitors. Merrill Edge only waives those commissions when certain conditions, as outlined above, are met. Customers who do not have large balances, to begin with, or do trade very frequently may find the fees and commissions a bit too much. In that sense, Merrill Edge is not a true discount brokerage as one might imagine.
Overall, if you are a Bank of America customer who already has accounts with the bank, Merrill Edge could be a great add-on to the banking service. If you like cutting-edge research, Merrill is a good option. If you are high net-worth and can meet the conditions for waiving of fees, Merrill Edge is an attractive option. But for other types of customers, there are better brokerages that you can sign up with.