When it comes to saving for retirement, it's hard to beat the usefulness of a Roth IRA -- which, unlike a traditional IRA, offers tax-free withdrawals. It's also hard to beat the Vanguard Roth IRA, with its minimum fees. Let's review Roth IRAs and how to open one. (Fear not -- opening one is very easy.)
Roth IRAs: a review
Recall that there are two main kinds of IRAs -- the traditional IRA and the Roth IRA. With a traditional IRA, you contribute pre-tax money, reducing your taxable income for the year, and thereby reducing your taxes, too. (Taxable income of $75,000 and a $5,000 contribution? Your taxable income drops to $70,000 for the year.) The money grows in your account and is taxed at your ordinary income tax rate when you withdraw it in retirement.
With a Roth IRA, you contribute post-tax money that doesn't reduce your taxable income at all in the contribution year. (Taxable income of $75,000 and a $5,000 contribution? Your taxable income remains $75,000 for the year.) Here's why the Roth IRA is a big deal, though: Your money grows in the account until you withdraw it in retirement -- tax free.
Note that Roth IRA contributions must be made with earned money. There's no minimumage for opening a Roth, but anyone funding their Roth IRA, whether child or adult, must do so with earned income. For kids, allowance or birthday money doesn't qualify, but cash earned through babysitting or odd jobs can. For adults, qualified earnings include wages, commissions, and even alimony payments, but not inheritances, Social Security benefits, or pension or disability income. The IRA contribution limit for 2016 is $5,500, plus an extra $1,000 "catch-up" contribution permitted for those age 50 or older, letting those folks sock away as much as $6,500 for the year.
IRAs can be great ways to build a better retirement for yourself, enabling you to save money in a tax-advantaged way for future use. The Fool has a great resource where you can learn more about IRAs to help you decide which type is best for your retirement goals.
You can open a Roth IRA at just about any major brokerage, and at many other financial institutions, too. Why Vanguard? Well, it has a rather excellent reputation -- for customer satisfaction, performance, and also for low fees. This summer, Consumer Reports magazine reviewed investment companies and reported the following:
- "Vanguard, the mutual-fund giant, scored very highly overall among both large investors (those who have more than $500,000 invested) and small investors (those who have less than $500,000 invested)."
- Large investors were satisfied with all the companies reviewed, but for small investors, Vanguard (as well as Dodge & Cox) stood out.
- "Vanguard beat out each of the other 30 firms in our ratings and is the only one to get a top mark for returns on investments."
The folks at NerdWallet recently reviewed Vanguard and noted:
- "Vanguard is the industry leader in low-cost mutual funds, ETFs, and index funds."
- "Vanguard's average expense ratio is 0.18% [for its mutual funds]; the typical equity mutual fund carries an expense ratio of 0.70%."
Vanguard itself notes that "93% of Vanguard mutual funds and ETFs (exchange-traded funds) performed better than their peer-group averages over the past 10 years."
The low fees contribute to the strong performances of so many Vanguard mutual funds. (Note that, of course, not every single fund is outstanding -- but on average, they certainly are.) Consider that 0.18%-vs.-0.70% difference, which would shrink a 10% average annual return to 9.82% and 9.3%, respectively. If you invest $10,000 annually for 25 years earning those returns, you'll end up with, respectively, $1.05 million and $968,000.
It's not that surprising that Vanguard is so respectable, as it was founded by John Bogle, father of low-cost index-fund investing. Vanguard mutual funds feature no sales loads and no sales commissions.
How to open a Vanguard Roth IRA
Vanguard explains how to open a Roth IRA on its website. Here are its steps, with a little extra commentary:
Step 1: Decide which IRA suits you best -- traditional or Roth. Review the pros and cons before you decide. For example, traditional IRAs are better in some situations, such as if you're in a steep tax bracket now and expect to be in a very low one in retirement. Roth IRAs are especially appealing if you have a long time before you expect to retire, which can permit your account to grow a lot.
Step 2: Choose an "all in one" fund or customize your portfolio. This simply means that you'll need to give some thought as to where you will deploy your dollars to grow. Target-date funds are one option, as they're based on your targeted retirement year and they allocate your funds between stocks and bonds accordingly, adjusting the mix over time as you approach retirement. Alternatively, you can select mutual funds on your own -- managed ones or simple index funds, which tend to have the lowest fees. (Seeking low or minimum fees can boost your ultimate portfolio performance.)
Step 3: Open your IRA online at Vanguard.com. Opening an IRA online is quick & easy. You can start with as little as $1,000 (but remember that the annual limit is currently $5,500 -- and $6,500 for those 50 or older). You can fill out the application form online, where you will need to name one or more beneficiaries. You'll then need to fund your account. Vanguard charges a modest $20 annual account service fee, but you can have that waived by registering your account online and signing up for electronic deliveries.
How can you fund your new Vanguard Roth IRA after you open it? You have several options. Let's review a few: You can electronically transfer money from your bank account to your new Vanguard account. (You'll need your bank account number and the bank's routing number, both of which appear on your checks.) You can mail in a check. You can also transfer an existing IRA that's housed at another investment company to Vanguard -- or you can roll over funds from an employer-based retirement account (such as a 401(k)) into a Vanguard IRA. It's smart to learn more or consult a financial professional before moving funds from one retirement account to another, as there may be tax or other issues to consider. For example, if you roll over money from a traditional IRA to a Roth IRA, you'll have to pay taxes on the money, as it was originally untaxed and Roth IRAs accept only taxed money.
You no longer have to wonder how to open a Roth IRA -- and a Vanguard Roth IRA in particular. Whether you go with Vanguard or another respected institution, it's smart to be regularly socking money away for retirement, ideally in tax-advantaged accounts.