What is an IRA and how does it work

What Is An IRA And How Does It Work?

What Is An IRA And How Does It Work?

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I have been consistently investing in IRAs now for decades. One of the first things you need to understand before you invest any of your hard-earned money is collecting the necessary information to make intelligent investment decisions. That is why it is critical that you understand what an IRA is and how it works. I’m going to share with you the exact same strategies that I have learned and still use today in my IRA accounts so that you can hopefully be successful in your retirement investment journey.

Can you lose money in an IRA?

Like any investment, investments in your IRA come with risk including loss of principal or the money that you put into your IRA. The best strategy is to invest in your IRA with a plan. You should have a clear set of goals, risk assessment and expected end state when you retire. Traditionally the stock market has gone up on average over time. An IRA is a retirement account, so if you invest early, invest consistently and often through dollar-cost averaging, you should appreciate great returns.

What is an IRA?

An IRA stands for an individual retirement account. They are tax-advantaged accounts used for retirement investment and savings.

What are the 4 types of IRAs?

There are four main types of IRA accounts:

1. The traditional IRA 

2. Roth IRA 

3. SEP IRA

4. SIMPLE IRA

For this article, we will focus on traditional, Roth and SEP IRAs. It is important you understand the mechanics of all three of these options, when to use them and how they could impact you from a financial and taxations standpoint.

For more information in regards to IRAs, click on the link to the SEC guide.

What is a traditional IRA and how do they work?

Traditional IRAs or individual investment accounts have federal income tax savings benefits, contributions grow tax-deferred, and your contributions and gains are subject to taxation when you make your withdrawals in retirement. 

What is a Roth IRA and how do they work?

Roth IRA contribution is subject to income taxation, but all your contributions and gains are tax-free when you take your withdrawals in retirement. In plain English, save taxes today and pay them later with the traditional IRA. With the Roth, you pay tax now but you never pay tax on the growth or the gains. 

There are also ways around these limitations called backdoor Roth’s. There are income limits to those who can contribute to a Roth IRA, please consult with the latest IRS tax codes for up to date information. 

IRAs are subject to taxation. Please click the link to the IRS website for additional information.

What is a backdoor Roth IRA?

A backdoor Roth IRA allows individuals that exceed the income thresholds to still contribute to a Roth IRA. This is pretty straight forward, you contribute to a traditional IRA and convert it to a Roth, paying taxes in the process of the conversion.

What is a SIMPLE IRA?

Due to the popularity of 401k and the low cost to implement them, Savings Incentive Match Plans (SIMPLE) IRAs are not widely used. They are typically available to small businesses that do not have 401k plans in place or any other retirement savings plan in place. They allow through the IRA employer and employee contributions at a lower cost but with lower contribution limits than with a 401k.

What is a SEP or Simplified Employee Pension Plan IRA?

A Simplified Employee Pension Plan or SEP plan allows employers to contribute to traditional IRAs (SEP-IRAs) set up for employees. A business of any size, even self-employed, can establish a SEP. Simplified Employee Pension (SEP) plans can provide a significant source of income at retirement by allowing employers to set aside money in retirement accounts for themselves and their employees. A SEP does not have the start-up and operating costs of a conventional retirement plan and allows for contributions of up to 25% of each employee’s pay.

If you’re interested in opening a SEP IRA, our number one recommended choice is M1 Finance. They offer a great mix of fund options to invest in.

What type of investments can I have in an IRA?

It is pretty amazing what you can have as far as investments in your IRA. You can invest in individual stocks, bonds, mutual funds, index funds, ETFs, REITs, cryptocurrency, commodities, precious metals and so much more. If you want to learn more about stock market investing please watch my YouTube video below.

For more information in regards to Mutual Funds and ETFs, click on the link to the SEC guide.

IRA dividend investment strategy and free IRA dividend investment calculator

Dividends are a great way to earn passive income in retirement. A dividend is a way that a large company can share its earnings with its shareholders? So, for example for every one share you own in the company, they will pay you out a piece of their profits over the course of a year. 

The Dutch East Inia Company was the first recorded public company to pay regular dividends. They paid annual dividends of around 18% per share over their 200-year existence. I wish they were around today because that’s a really nice yearly payout! 

Here is the link to the free dividend investment calculator to help plan out your dividend portfolio investment strategy. 

If you want to learn more about dividend investing please watch my detailed dividend investing YouTube video below.

Actively invested, passively invested, Robo Advisor and traditionally managed IRAs

You have the choice of either purchasing individual securities on your own, handing off the investments to a Robo Advisor, or a financial professional to manage your IRA investments. Robo Advisors are software algorithms that take your specific inputs to put together a retirement investment for you in your IRA.

How much does an IRA cost per year?

This all depends on who you use as an IRA account provider, what type of IRA account and what investments you plan on having in it. For the most part, I like to open IRAs where there are no fees associated with them and those allowing me the most flexibility in investment types. 

IRA tax strategies

Personally, I prefer Roth IRAs over the traditional IRAs in most situations. Sometimes a combination works as well. The reason I prefer the Roth is that I believe there are two guarantees in life, death and taxes. If there is one thing, it is that taxes seem to always go up and not go down. So, for me, there is nothing better than knowing what I invest today grows tax-free and the money I take out in retirement is completely tax-free. For that very reason alone I prefer in almost every situation the Roth IRA over the traditional IRA. Again, everyone’s situation could be very different depending on earnings, age, and other conditions. If necessary, speak with a financial professional or coach to get additional guidance if you need it.

Who offers the best IRA accounts?

Depending on your needs I have three specific recommendations. 

Our #1 rated Robo advisor for both IRA and traditional brokerage investing is M1 Finance. It’s free to open an account, you can use their Robo advisory services or actively invest in stocks and funds on your own. They also offer all three types of IRAs for you to start. Accounts are free to open and you can start investing with as little as $100. Check out M1 Finance below.

#1 Rated Robo Advisor & Dynamic Portfolio Rebalancing

#1 Rated Robo Advisor & Dynamic Portfolio Rebalancing

The M1 Finance investment, retirement account and technology are simply amazing. They even offer dynamic re-balancing, full customization and even some pre-built portfolio options called expert pies. M1 is a strong recommendation for your automated investment and retirement needs. Try them today with only as little as $100 to start investing.

M1 Finance custom pies

If you’re looking for a completely automated Robo Advisor, for an IRA retirement investment account only, then our #1 rated automated retirement Robo Advisor platform choice is Acorns. Their platform takes spare change from your everyday spending and automatically invests it for you. They do charge a small monthly management fee for their services. Learn more about Acorns below.

#1 Rated For Automated Funding Of Investments

#1 Rated For Automated Funding Of Investments

Automate your retirement investing through your spare change and intelligent Robo advisor services. Setting up an account takes less than 5 minutes. They now offer no-fee checking as well. If you want to put your spare change to work to help grow that retirement nest egg, there is no better product on the market than Acorns.

Acorns App Phone 1

If you have $100,000 to invest and you’re looking for a hybrid of Robo Advisor and traditionally managed accounts, at Ultra-low costs, then you have to look into Personal Capital. Check them out below.

#1 Rated For Automated Funding Of Investments

#1 Rated For Net Worth Analysis & Managed Investments

Hands down, Personal Capital is the best platform for you to calculate your net worth. Personal Capital also fills in all the gaps I tend to find with Mint as well. They also have a very robust portfolio management offering that is a hybrid of a managed and Robo advisor. The best part of all is that their net worth and portfolio projection tools are completely free to use. 

Personal Capital Screen Views Phone

SECURITIES INVESTOR PROTECTION CORPORATION (SIPC) protects against the loss of cash and securities – such as stocks and bonds – held by a customer at a financially-troubled SIPC-member brokerage firm. Click here to learn more information.

Summary

IRAs are an essential vehicle for retirement investing. Remember to take into consideration longevity, health, where you want to live, your lifestyle and other factors when considering your IRA retirement investment strategy. Time is on your side for financial success if you start investing early and consistently. 

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Frank Makrides

Frank Makrides

Is a former financial technology industry executive, licensed realtor, real estate investor, an award-winning speaker, has been published, holds multiple patents and is passionate about all things personal finance and entrepreneurship. He is also a proud husband and father of 2 amazing children.

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