Opening an IRA (Individual Retirement Account) is one of the most important things you can do on your way to achieving financial independence, and I think it’s absolutely crucial because it’s basically a way to get free money, and who doesn’t want free money?
Let me explain. We all work and have an income and we have expenses and we can all use our intellect and resources to change our financial situation and bend the equation in our favor but one thing that we do not have control over is the tax code. The tax code is crazy and complicated and convoluted and it doesn’t really matter whether we like it or not, or agree with it, but it is what it is.
So if we accept the tax code as it is we have the opportunity to understand it and maximize the benefits and minimize the harm it does to our income. The very first, most basic advantage that we can ever get to save and invest is to open an IRA. Anyone can do it, you don’t need to be employed, or ask permission…you can just open one and start putting money in it.
The Many Advantages of an IRA
The current annual limit that you can put into an IRA is $5,500. That’s fine but what’s really important to know is that this is also the amount that you can deduct directly off your taxes. That’s right, in a simple example, if you earn $5,500 and put it all in your IRA in the same year, you will owe no taxes. That’s pretty powerful. Combined with the other standard deductions on your tax forms it’s very possible to earn $15,000 to $20,000 per year and pay little or no taxes.
In addition, you can deposit money into your IRA account at any time of the year, in any increment, and in fact you can even make deposits all the way through April 15th for the previous year, or until you file your taxes.
What to Look for in an IRA
There are lots of great IRA choices. Here are a few important things to consider when opening a new IRA. Of course the first thing that you want to consider is fees. An IRA should be free to set up and trading fees should be low. An IRA is not traditionally a trading account but you will need to buy stocks when you make a deposit. Lower fees are always better.
The brokerage should make it easy to make deposits. For my account I linked my checking account to my IRA so that I can make deposits into my IRA at any time, in any amount and I can easily see my deposits and what tax year they are applied to. The next thing that is important is good customer service. Can you actually talk to a human when you need help? I get tired of the Most Commonly Asked Questions because my question never seems to be on the list. I want to talk to a human!
Another service that is important is the ability to automatically roll over my dividend payments into new stock purchases without a trading fee. This is relatively common and is usually called a DRIP, or Direct Reinvestment Program, or something similar. Fees are bad as we know and it’s important to minimize or avoid them wherever we find them. Finally, I want to be able to easily see my tax statements within my account understand what’s going on.
In summary, one of the most important tasks that you can accomplish on the way to financial freedom is to invest tax free. The compounding of tax free investments is astounding over time so get to it and open an IRA!