For many people, an individual retirement account, or IRA, is a cornerstone of their retirement plan. Like a 401(k), it allows people to save and invest their income to use as living expenses after they reach retirement age. IRAs can be funded directly, or when you leave a job, you have the option of moving your 401(k) assets into an IRA, which is called a rollover.
An IRA is one important way to save for retirement, but you may have questions about how and where to invest your IRA assets. The IRA is a financial instrument, but you’ll need to come up with your investment strategy on your own.
The first and biggest choice is whether to find an advisor to help manage those assets or to invest them yourself. Making that decision depends on a number of factors, such as your plans for retirement, your comfort level with making active investments and your outlook on the long-term impact of fees.
Starting With a Plan Is Essential
When deciding whether you to manage your retirement accounts yourself or seek support, you might first want to consider what you need to accomplish. The first step of any savings plan is to define your goals and timeline.
● What is your financial goal? How much of your retirement income will your IRA eventually amount to? If it’s your sole retirement account, you may want to contribute the maximum pretax dollars every year (more on that below), but if it’s a supplemental account—to your 401(k), for example—you may not need to, especially if over-contributing would strain your budget.
● When will you retire? Are you planning to retire in five years? Ten years? Thirty years? The answer will help you decide on your investment strategy and risk tolerance. (You can take money out of your IRA at any time, but any withdrawals you make before age 59½ may result in additional taxes.)
Your strategy is what will determine the types of investments you want to make in stocks, bonds and cash equivalents, such as certificates of deposit, or CDs, and money market accounts. To decide how much of your IRA to place in each type of investment, the conventional wisdom says that you should invest more heavily in stocks and stock-based mutual funds early on and gradually shift to less-risky investments such as bonds and cash equivalents as you get closer to retirement.
If that already sounds too complicated, an advisor can help you flesh out your IRA strategy and implement it. But remember that advisors charge fees, which can reduce the amount of money in your account over time.
When Should You Manage an IRA Yourself?
There are a few advantages to having a self-directed IRA that you manage. The first is that you’ll pay lower fees, depending on your plan and the investments you choose. The second advantage of doing it yourself is control. With IRAs, you can invest when you want, how you want, and make changes on the fly.
● Consider fees. Some self-directed IRAs charge account maintenance fees or charge for trading costs, so you’ll have to pay for every stock you buy or sell. Many investment options, such as mutual funds and exchange-traded funds, charge management fees. Those come out of your account on a regular basis, regardless of how your investments perform, so it’s important to read the fine print and see what you’ll be paying. If you have a simple strategy and you’re comfortable setting up a self-directed IRA, then you will likely pay lower fees if you decide to manage your own IRA versus hiring an advisor.
● How much control do you need? With an IRA, you can purchase investments using pretax dollars by contributing a little each pay period or each month until you either reach your annual savings goal or hit the IRA’s annual investment maximum. This approach will help you slot your retirement savings into your monthly budget.
Take advantage of the different kinds of IRAs that are available. If you’re worried about paying high income taxes in retirement, then a Roth IRA may make sense. With a Roth, you buy investments using your post-tax dollars, but pay no income taxes on it when you cash out in retirement. If you own your business, you might want to look into a SEP IRA or a SIMPLE IRA.
When Should You Work With an Advisor or Broker?
Not everyone is comfortable investing. Most people are not good at choosing individual stocks, nor do they have the time to properly vet investments. But to save enough for a comfortable retirement, your money must grow over time. That’s where an advisor can be helpful.
If you choose to work with a personal financial advisor, make sure it’s someone you can trust. Talk to more than one candidate, and get a referral from a trusted contact if possible. Before you sign anything, ask a potential advisor about their fees and their fiduciary position, and check their credentials.
Depending on the assets you have to invest, you may not have enough money to work with a traditional financial advisor. But you can still get help. You may consider a low-cost financial advisor who will charge you by the hour for specific advice.
Many online brokerages also offer so-called robo-advisor services. To work with one, you’ll usually fill out a questionnaire about your goals, life stage and your comfort level with investments and the risks that come with them. Using that information, the robo-advisor will set up an investment plan and automatically rebalance your IRA portfolio as the markets change and your time horizon to your goals decreases.
Steps to Consider With Any IRA
The biggest advantage of a traditional IRA is that you can fund it with pretax dollars, allowing you to invest more money upfront and reduce your taxable income for that year. So look closely at the tax advantages of the IRA you choose, whether it’s a traditional or Roth IRA. The decision you make could have tax implications this year and later on, in retirement.
The next step is to decide how you want to fund your IRA, whether it’s monthly or annually. Having a plan will help you make the most out of your IRA over the long term. And when buying investments in your IRA, remember what you’re investing for and stick to your strategy.
Colin Dodds has written for preeminent media and financial companies. He is the author of several acclaimed books, including Ms. Never and Watershed. He lives in New York City with his wife and children.
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