Individual retirement account (IRA) growth depends on many factors. It relies heavily on the amount of money invested and how much risk the investor is willing to take, which shapes what types of investments are included in the account. Making regular contributions to the account also has a dramatic effect on the performance.
How Contributions Affect Growth
One big factor that determines the growth of an IRA is contributions. As of 2019, IRA contributions are limited to $6,000 a year (up from $5,500 in 2018), or $7,000 if you are age 50 or over (due to an extra $1,000 allowed via a catch-up contribution). If $6,000 is invested annually in an IRA at a return of 5% after 30 years the account would be worth over $400,000. The fact that the interest can be reinvested and grow tax-free doesn't hurt either.
The Magic of Compounding
Of course, to beat inflation, it is necessary to invest in higher-risk investment vehicles such as individual equities, index funds or mutual funds. IRAs can invest in a range of securities offered by various entities: public corporations, general partnerships (GPs), limited partnerships (LPs), limited liability partnerships (LLPs) and limited liability companies (LLCs). Investments held in IRAs that are related to these entities include stocks, corporate bonds, private equity and a limited number of derivative products. Not every investment is eligible for an IRA, however, such as antiques or collectibles, life insurance, and personal-use real estate, among others.
Stocks are a popular choice for IRAs because the earnings gained are basically extra contributions to the IRA. Stocks also grow IRAs through dividends and increases in share price. While no one can predict the future, the annual range of return for stock investments has historically been between 8% and 12%. For example, by investing $6,000 a year in a stock index fund for 30 years with an average 10% return, you could see your account grow to over $1 million (though be aware of the impact of investment fees). With such great potential to grow funds consistently over time with the magic of compounding, it is clear why stocks are almost always featured in IRA accounts.
Higher-risk investments such as stocks help grow IRAs most dramatically. More stable investments, such as bonds, are often included in IRAs for diversification, and to balance out the equities' volatility with a stable income.
Roth vs. Traditional IRA
The main difference between the two kinds of IRAs is whether or not you want to fund your IRA with pretax dollars or not. A traditional IRA is funded with pretax dollars. When you retire and begin to access a traditional IRA, you are responsible for paying income tax on the funds. A Roth IRA is funded with after-tax dollars, and any contributions you make are not subject to taxes if you make a withdrawal. Contribution limits for Roth and traditional IRAs are the same, but there are age limits for how long you can fund a traditional IRA. At 70½ years of age, contributions to a traditional IRA must stop, but a Roth can be funded up until any age. If you opt for a traditional IRA, you have to start taking RMDs (required minimum distributions) at age 70½. As per the IRS, traditional IRA owners must begin distributing minimum amounts beginning April 1 of the year following the year they turn age 70½. Beneficiaries are also subject to the RMD rules if they inherit a traditional IRA. A Roth IRA does not have any RMD rules unless you inherit one because beneficiaries must take them.
Opening an IRA
An IRA can be opened through a range of major financial institutions. They include brokerages, mutual fund companies, and banks. IRAs can also be opened through online brokerages. The major difference between most IRA providers lies in what they charge for their services.
Just about any wage-earner can set up an IRA. Employers or self-employed individuals who want to establish retirement plans for themselves or their employees often consider simplified employee pension individual retirement account (SEP IRAs). SEPs have lower costs for setup and maintenance than traditional retirement plans do.
The Bottom Line
Few investment vehicles are as versatile as IRAs. Many options are available for investors to personalize accounts to help reach their financial goals, and thanks to compounding interest, IRAs will continue to grow even if you are unable to fund them every single year. A valuable tool for investors of any experience level, IRAs offer the flexibility to be hands-on or to leave the choices to the professionals on their behalf. With so many options for funding IRAs and the probability for high returns, it is no surprise that over 30 percent of households contribute to either a traditional or Roth IRA.