Daniel writes in:
I decided to sign up for a Roth IRA and started the process at Vanguard but it’s complicated with a lot of legalese. Do you have a walkthrough?
I’m a little hesitant to write a detailed walkthrough of how to sign up for a Roth IRA on a specific website because the exact details of where to click are likely to change regularly. However, the overall process of signing up is very similar at most investment firms, so I’m going to write a general overview of the process instead.
The first step, of course, is the actual decision to sign up for a Roth IRA. A Roth IRA is a tool for saving for retirement that’s available to a large majority of Americans. Which ones? If you are single, you must have a modified adjusted gross income (MAGI; this is a specific line on your income taxes that more or less correlates to how much you make in a year with a few tweaks) under $135,000 to contribute to a Roth IRA this year, but contributions are reduced if your income is between $120,000 and $135,000. Similarly, if you are married filing jointly, your MAGI must be less than $199,000, with reductions beginning at $189,000. This covers more than 90% of Americans, so you’re most likely eligible to contribute.
So, what exactly IS a Roth IRA, then? You can think of it as a special kind of savings account that has some tweaks that make it particularly useful for people who are using it to save for retirement. Just like a normal savings account, you put money in there, it earns a return on your money, and you can take money out of there and put it back into savings. However, there are a number of key differences.
First, you’re allowed to contribute a maximum of $5,500 a year, or $6,500 a year if you’re over age 50. That’s the current annual limit of how much you’re able to put into the account, and nothing can change that. If you take money out, that doesn’t change the amount you’re allowed to put in at all.
Second, you have to choose an investment once you’ve put money in the account. Unlike a savings account, a Roth IRA offers a lot of investment options once you have money in the account. You essentially get to decide what the company managing your Roth IRA does with your money. The easiest route for most people is to choose a Target Retirement fund, which essentially manages your investments and balances out the risk automatically, with a lot more risk when you’re young gradually changing into a lot less risk when you’re close to retirement. However, you can choose other things; you can even split up your money amongst a lot of options.
Third, if you meet a couple of simple rules, you can withdraw your earnings tax-free from that account. This is the big advantage of a Roth IRA. If you’re at least 59 1/2 years old and you made your first contribution more than five years earlier, you can withdraw money tax-free from that account.
This is different than a savings account. If you have money in a savings account, it will earn interest in a small trickle. Each year, your bank will issue you a tax form and you have to pay taxes on the interest you earn in that savings account right away. With a Roth IRA, as long as you leave the money in the account, you don’t have to pay taxes right away on anything your investments earn. You only have to pay when you withdraw money, and if you follow the withdrawal rules stated above, you don’t have to pay any taxes when you take the money out. That’s a big advantage, because it’s basically money you can have in retirement for which you don’t have to pay any income taxes.
So, how do you actually sign up for this, assuming you’ve decided to do so?
The first step, of course, is deciding where to sign up. Just like there are a lot of banks to choose from when signing up for a checking account or a savings account, there are a lot of investment firms to choose from when signing up for a Roth IRA.
I’m the last person to simply tell you which one to choose. Most large investment firms have advantages and disadvantages. Some offer really nice tools for comparing investments and a lot of over the phone assistance if you need help, but they tend to have a lot of fees. Some have different philosophies when it comes to what kinds of investments they offer to people – again, with different fees.
I personally use for my Roth IRA. Vanguard focuses on index funds, which are a particular type of investment with some nice advantages (very low fees) due to the fact that they’re basically just collections of investments that meet certain criteria. I’m a fan of index funds, so I use Vanguard, because index funds are their specialty.
There are many, many investment firms out there to choose from. Fidelity has a good reputation. Charles Schwab tends to always get good customer satisfaction numbers in surveys. I strongly encourage you to do a little research in this area and choose one that’s right for you. Money magazine and Kiplinger’s Personal Finance often run articles comparing different investment firms, so one great way to do this is to hit the library and look through recent issues of those magazines.
Once you’ve decided on a good firm for you, signing up is usually a matter of filling out some online forms at the company’s website. They’ll ask for quite a bit of information, including your Social Security number, because they report your financial information to the IRS as is their legal requirement. Most of it is straightforward – your address, a username and password for your account, and so on.
Almost all financial firms will also want you to link your new Roth IRA to a checking account. There are a number of ways that they do this; the most common way is that they’ll ask you to enter your bank’s name, your bank’s routing number (which can be found on a check), and your account number at that bank. After that, they’ll go through some verification process which will take a few days; often, they’ll deposit two small amounts (a handful of cents) and then have you verify the deposit on their website, just to make sure that the account info is correct. So, you’ll have to sign up, then wait a few days, check your local bank for a couple of small deposits into your checking account, and then log back on and enter the amounts of those small deposits. This is a verification procedure so that the investment firm can trust any money transfers from your checking account.
So, the information you’ll need will include your address, your phone number, your Social Security number, your bank’s name, your bank’s routing number (which you can find on the bottom of a check), and your checking account number (which you can also find on the bottom of a check).
One thing you’ll need to consider is automatic transfers. Almost all investment firms strongly urge investors to set up an automatic transfer from their checking account to the Roth IRA, moving money on a regular basis into the Roth IRA. The reason for this, for you as an investor, is to take the decision to contribute to the Roth IRA off the table. Each week or month (depending on the frequency you choose), the investment firm will handle the contribution automatically for you – you don’t have to remember to do it and you can’t choose to talk yourself out of it.
For example, you might elect to contribute $20 a week or $50 a month. (A contribution of $100 a week will get you close to the annual contribution limit.) It’s an effective way to make sure you stay on track for retirement; I recommend automatic investing for almost everyone’s Roth IRAs.
Another element of signing up is choosing your specific investments. You’re going to have a lot of options – most Roth IRAs offer all (or almost all) of the investments available from that investment firm as well as some options from other firms, and that can end up being a lot of options.
Many people get bogged down at this point with analysis paralysis. Don’t let that happen. Choosing an investment option is a great example of how the perfect is the enemy of the good. You are far better off choosing a good investment and starting your contributions right away than you are sitting around looking for the perfect investment and waiting to get started.
If you’re looking for a good investment, you’re almost always making a good choice by choosing a Target Retirement fund with a year close to your retirement year – so, if you’re going to retire in roughly 2050, choose the Target Retirement 2050 fund. It may not be perfect, but it’s virtually always good. Most people can pretty safely put their money into a Target Retirement fund and never think about it again until retirement unless they choose to start carefully studying investments. I personally use a Target Retirement fund for some of my retirement savings – I actually want a little more risk than it offers, so I put another portion of my retirement savings into a Total Stock Market Index Fund. That’s a personal decision, though, and my retirement savings would be very similar if I had just put everything into a Target Retirement fund and forgot about it.
That’s it! Once you’ve chosen your investment firm, signed up for an account there with your own information, linked it to your checking account, chosen an investment option, and started an automatic transfer, you’re done. Just sit back and let your retirement build. You only have to think about it when you want to. It’s not a bad idea to check in on it occasionally, but you won’t be missing much of anything if you just let it ride for months or even years at a time.