There are several options when it comes to saving for retirement. You could stick to a traditional brokerage account, put your money in the bank, or enroll in your company's 401(k). But if you want to capitalize on one of the greatest retirement savings tools out there, you'll open an IRA.
One key benefit of IRAs is that unlike traditional brokerage accounts, they offer tax-advantaged growth. If you open a traditional IRA, you'll get to make tax-free contributions, and your investments can grow tax-deferred until the time comes to take withdrawals in retirement. With a Roth IRA, your contributions will be made with after-tax dollars, but your investments will grow tax-free, and your withdrawals in retirement won't be taxed.
Traditional brokerage accounts don't work that way. When you invest with a traditional brokerage account, any time you realize a gain, you're required to pay taxes on your earnings. Because you won't pay capital gains taxes year after year with an IRA, you're free to reinvest your earnings and grow your money even more.
A wide range of investment opportunities
While 401(k)s come with a higher annual contribution limit than IRAs ($18,000 a year for savers under 50, versus just $5,500), they tend to offer somewhat limited investment choices. This can be problematic for two reasons. First, if you don't have many options for investing your money, you could end up with a portfolio that doesn't match your style or address your tolerance for risk. Secondly, if you're forced to choose high-fee investments, you'll end up losing a larger chunk of your earnings over time.
IRAs are known to offer a wider range of investment choices than 401(k)s, and as such, you're more likely to find something suitable for your taste and needs. Just as importantly, investing with an IRA could help you avoid excessive fees that might really add up over time.
You can save for more than just retirement
One final benefit of IRAs is that they offer a fair amount of flexibility when it comes to accessing your money. With a Roth IRA, you're allowed to withdraw your principal contributions at any time and for any reason -- no questions asked. Traditional IRAs impose a 10% penalty if you withdraw money prior to age 59-1/2, but there are a number of exceptions that allow you to avoid that fate.
First, you can withdraw money from a traditional IRA to pay for higher education costs for yourself, a spouse, or a dependent. You're also allowed to remove money early from a traditional IRA to pay for medical care provided your costs exceed 10% of your adjusted gross income. Furthermore, you can withdraw up to $10,000 from a traditional IRA penalty-free to purchase a first-time home. And if you're married, you and your spouse can each remove $10,000 from your respective IRAs and apply a total of $20,000 toward a first-time home purchase.
Of course, for most people, the purpose of an IRA is to save for retirement, and if you withdraw funds for other purposes, you may come up short in your golden years. But if you have a separate retirement account, like a 401(k), and you open an IRA for the express purpose of saving for college or a first-time home, you'll benefit from the aforementioned tax breaks while retaining the flexibility to use that money for your immediate needs or retirement.
Though an IRA isn't your only choice when it comes to saving for retirement, if you start early enough and max out your annual contributions, you stand to amass a pretty respectable sum over time. Case in point: Saving $5,500 a year for 30 years will give you an ending balance of $623,000 if your investments generate an average annual 8% return (which is right below the stock market's average). To make the most of your IRA, however, you'll need to start funding it as early as possible in your career, so if you've yet to get started on retirement savings, now's the time to action.