If you're interested in saving effectively for your retirement, it's hard to beat a Roth IRA. Among all the providers of Roth IRAs, what's the best one for you, with low fees and rates, and reasonable minimums to open an account? Here's a review of Vanguard, a solid option.
Open a Roth IRA
First, though, let's review what IRAs are, why you might want to use one to save for your retirement, and why Roth IRAs are particularly powerful. 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 $65,000 and a $5,000 contribution? Boom -- your taxable income for the year is now $60,000. 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 $65,000 and a $5,000 contribution? Your taxable income remains $65,000 for the year. What's the point of the Roth, then? This: Your money grows in the account until you withdraw it in retirement -- tax free.
How much to start?
So how much money should you park in a Roth IRA to start using it? Well, Vanguard accounts generally have no minimum investment amount required to open them -- though the company's mutual funds sport minimums of $1,000 and, often, $3,000. So you can open and maintain a Roth IRA at Vanguard with just $,1000 or a few thousand dollars. But investing only small sums in an IRA kind of defeats its purpose and potential: helping you accumulate a lot of money for retirement. (That's a really important goal, by the way, since fewer and fewer of us have pensions to look forward to these days.)
When, then, is the maximum you can park in an traditional or Roth IRA? Well, IRA contribution limits for both 2016 and 2017 are the same: $5,500. There's also 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. Here's an idea of what such sums can do: If you invest $5,500 each year in a Roth IRA for 25 years and it grows by an annual average of 8%, you'll end up with more than $430,000! (And in a Roth IRA, it won't even get taxed upon withdrawal.) Contribution limits are increased every year or few years, so aim to keep contributing the maximum to your IRA over time.
Vanguard's rates and fees: a review
Now let's take a closer look at Vanguard. It rates four out of five stars from the folks at NerdWallet, who like its funds' low fees and generally good performance but don't love some of its fee structures. For example, its trades cost $7 each for the first 25 per year, but then $20 apiece after that -- if your account's value is less than $50,000. That's not necessarily bad for many investors, though, as trading frequently can reduce your returns. Vanguard charges a $20 annual service fee, too, but that's waived if you agree to receive electronic deliveries or have an account balance above $50,000.
Vanguard's low fees are worth emphasizing, as seemingly small differences in fees can make a big difference over many years. As the company itself notes, "The average Vanguard fund expense ratio [annual fee] is 82% less than the industry average."
A particularly appealing aspect of Vanguard as an IRA administrator is that it's not only a massive mutual fund company, giving you easy access to many different kinds of funds, but it's also an index fund giant. In fact, Vanguard's founder, John Bogle, is known as the father of index funds and has long been a strong advocate for individual investors.
What's the best investment for your Roth IRA?
So what, exactly, should you invest in, in your Roth IRA? Well, mutual funds are a convenient solution, as they offer instant diversification across whatever segment of the market they cover -- and some cover the entire U.S. or world stock market. Vanguard has a range of actively managed funds (that is, ones where financial pros are selecting which securities to buy and how long to hold them), but it's known for its index funds (which are passively managed). That's a good thing, because index funds tend to outperform actively managed funds. Indeed, according to the folks at Standard & Poor's, as of the end of June 2016, fully 87% of all domestic stock mutual funds underperformed the S&P 1500 Composite Index over the past 10 years. And 85% of large-cap stock funds underperformed the S&P 500. If you want to go the index fund route, one of Vanguard's funds to consider is its offers the solid Vanguard 500 Index Fund (NASDAQMUTFUND:VFINX), with a very low expense ratio of 0.16%. To diversify further, check out the Vanguard Total World Stock Index Fund (NASDAQMUTFUND:VTWSX), with a still-low expense ratio of 0.25%.
Whether you go with Vanguard or not -- and there are plenty of other very good brokerages -- be sure to consider making the most of a Roth IRA.
Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, owns no shares of any company mentioned in this article. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.