Since their inception in 1982, individual retirement accounts (IRAs) have grown to become one of the most popular retirement savings vehicles in America. Virtually every financial institution in the country offers this type of account, including banks, brokerage firms, independent investment advisers, life insurance companies and trust companies. However, knowing which type of account is right for you can be difficult unless you know exactly what it is that you need.
TUTORIAL: Retirement Plans
Types of IRA Custodians
If you want to invest your IRA in CDs or other guaranteed instruments, then a bank or fixed annuity carrier is probably your best bet. If you prefer to invest in stocks or other securities such as mutual funds, then a brokerage firm or investment advisor will be able to meet your needs. Mutual fund companies also offer IRAs that invest directly in their own fund families. If you are content to invest with a single fund company, then this may be the most convenient option for you. There is probably no one "right" option for most people; many different institutions can do many of the same things. For example, most banks have investment consultants who can purchase mutual funds and other securities just like a conventional stockbroker or investment advisor, and many life insurance companies can offer IRAs that invest in mutual funds through a variable annuity contract. (For more, read Is Your Mutual Fund Safe?)
Fees and Deductions
You should always find out whether or not your IRA charges an administrative fee of any kind. Many IRAs charge anywhere from $25 to $100 per year to cover administrative and custodial costs (this fee is often waived for customers with balances above a certain amount, such as $100,000 or $250,000). Of course, all IRA custodial fees can be written off on Schedule A of the 1040 form for those who are eligible to itemize deductions as a miscellaneous investment expense. Those who have created investment companies and make a business out of managing their investments can deduct these fees as an above-the-line business expense.
Most IRA custodians will also now allow you to transfer money electronically to and from your account and will even calculate your required minimum distribution (RMD) for you and send it to you if necessary. Most custodians can send your RMDs on a monthly, quarterly or annual basis according to your wishes. However, most IRAs that are offered by institutions, such as banks, insurance and fund companies, will not allow you to buy certain types of investments, such as derivatives, oil and gas interests or real estate.
If you want to do this, then you will have to use one of the self-directed IRA custodians that can facilitate this type of transaction. Therefore, in order to choose the type of IRA that's right for you, you will need to have a clear idea of what types of investments you intend to purchase, what firms are willing to take custody of them and also the general level of fees that you are willing to pay for this.
Obviously, this is a fairly easy task in many cases. If you want to invest your IRA in CDs, then any bank will do. Just do some comparison shopping to see who has the best rates. Other times this is a more complex issue, especially for those who want to buy mutual funds or equities. A good deal of research may be necessary in order to determine the selection of investments that best meets your needs. (For more on controlling your assets, read Manage My Own Investments? Are You Kidding?)
Traditional Vs. Roth IRA
One of the biggest decisions that IRA owners must make is whether to contribute to a traditional IRA that has deductible contributions and taxable distributions or a Roth IRA that has nondeductible contributions and tax-free distributions. In many cases, the Roth is the clear choice, especially for those in a lower tax bracket who will not benefit materially from the current deduction they get for their annual contributions. Roth IRAs also do not have mandatory minimum distributions that must begin at age 70.5.
The Bottom Line
There are several factors that can determine which type of IRA is right for you, including your tax bracket both now and at retirement, your investment objectives and time horizon, and the manner in which you plan to take your withdrawals. For more information on IRAs, download Pub. 590 from the IRS website at http://www.irs.gov/ or consult your financial advisor.