If you’re just starting out, you may want to stick to basics: a traditional or Roth IRA. You can put in as much as $6,000 for the 2020 and 2021 tax years (plus an additional $1,000 if you’re 50 or older). With a traditional IRA, your contributions may be deductible, and the growth is tax-deferred.
If you’re not covered by an employer plan, your traditional IRA contributions are deductible, with no income limits. But if you have a spouse covered by a plan, income limits may apply. For more details, check the IRS website.
With a Roth IRA, your contributions are made on an after-tax basis, but your money will grow tax-free, and you’ll pay no taxes on your distributions as long as you follow the withdrawal rules. (Generally, you must have held the account for five years and have turned 59½ or older.) Plus, you can take out your own contributions anytime without paying tax.
Which IRA is right for you? A lot depends on your age and current income. Young people, for instance, are likely to have smaller incomes and thus pay less than they will when they get older.
“If you think that your taxes will be higher later than they are today, a Roth IRA might be better,” says Wade Pfau, a professor of retirement income at the American College of Financial Services.
Conversely, those with higher incomes might want to get the immediate tax deduction with a traditional IRA. (This calculator can help you choose between a Roth and a traditional IRA.)
It’s impossible to know with any certainty how your taxes might change years from now, which is why many financial advisers suggest hedging your bets. Contribute to both types of IRA, though you’ll need to keep your total contributions under this year’s $6,000 (or $7,000) limit. And revisit your choices periodically as tax rates and your income change.
Whichever IRA you choose, set up an automatic investing plan to ensure that your savings really happen, which is a key advantage of an employer 401(k). At most fund companies and brokerages, it’s simple to do this online. Just enter your bank information, how frequently you want to invest, and the amount of the transfer.
“If you’re not sure about your cash flow, it’s fine to start out with small amounts, even $100 a month,” says Marguerita Cheng, a certified financial planner and CEO of Blue Ocean Global Wealth in Gaithersburg, Md. “You can increase the amounts later, when you have a better feel for your income.”