How to Invest Through an IRA

By Peter A. Elwell, CFA | March 25, 2024

Man looking at IRA Investment options on laptop.

Nearly 50% of adults aged 55 to 66 in the U.S. have no retirement savings. You deserve to reap the benefits of a retirement savings and investment account that gives you peace of mind for the future. An individual retirement account (IRA) can do just that. These accounts, which are generally self-managed, enable you to contribute to compounded savings that grow tax-deferred or tax-free. 

Several types of IRAs may suit your financial needs and goals, whether you’re just starting out in your career or nearing retirement. If you’re unfamiliar with this retirement investment or want to know more, this guide explains how to start an IRA and the potential benefits and drawbacks you may experience.

What Is an IRA?

Individual retirement accounts are retirement savings vehicles that taxpayers can open to invest in their future. Individuals put money in an IRA account and use that money to invest in various securities, including:

  • Stocks 
  • Bonds
  • Mutual funds 
  • Exchange-traded funds (ETFs)
  • Certificates of deposit (CDs)

People invest through IRAs instead of in these securities directly because IRAs are tax-advantaged accounts. Depending on the type of IRA, investors receive tax-free withdrawals or tax deductions for their contributions. Many factors limit how much an account holder can contribute, including income, type of IRA, and the account holder’s age. 

Individuals can open an IRA with a financial institution such as a bank, brokerage company, or credit union. Anyone earning income is eligible to hold an IRA if they meet income eligibility requirements. Additionally, a non-working spouse can still benefit if their working spouse elects to open and contribute to an IRA on their behalf.

Individuals may hold more than one IRA at a time, even if they already have an employer-sponsored retirement plan, such as a 401(k), through their job. However, having more than one IRA does not mean a taxpayer can contribute more than the annual contribution limit set by the Internal Revenue Service (IRS), which we’ll outline below.

What Are the Different Types of IRAs?

The rules and requirements for an IRA differ depending on which one you choose. We’ve compiled a list of the main types of individual retirement accounts so you can make a better-informed decision and invest with more confidence.

1. Traditional IRA

Traditional IRAs generally allow holders to withdraw funds from the age of 59.5 without penalty.

A traditional IRA offers tax deductions on contributions for the year you contribute, but it depends on your filing status and income. Most traditional IRA holders must pay income tax or earnings when making withdrawals. This type of IRA generally allows holders to withdraw funds from the age of 59 ½ without penalty. If you wish to withdraw money before that age, you will likely be subject to a 10% penalty, though there are certain exceptions.

Traditional IRAs are subject to minimum required distributions. This is the amount that you must begin withdrawing from your account once you reach a certain age. For traditional IRAs, it’s 72 years old. The annual contribution limit for traditional IRAs for 2023 is $6,500 or $7,500 if you’re 50 or older.

2. Roth IRA

Roth IRAs are sometimes thought of as a counterpart to traditional IRAs. Unlike a traditional account, contributions to a Roth IRA are made with after-tax dollars, so account holders do not receive tax deductions upfront. However, this means that qualified distributions are not subject to taxes or penalties. Another benefit of Roth IRAs is that there are no required minimum distributions until the account owner dies.

Roth IRAs have income limits that determine how much an account holder can contribute each year. Depending on your income, marital status, and tax filing strategy, you may only be able to contribute a reduced amount of the annual limit. Those who make over a certain amount of income may not be eligible for a Roth IRA at all. The annual contribution limit for a Roth IRA is the same as a traditional IRA, though it usually changes every year.

3. Self-Directed IRA

Self-directed IRAs are special traditional or Roth IRAs that offer more flexibility when it comes to investing in certain asset types. The IRS generally restricts IRA holders from investing in the following investment types:

  • Metals
  • Antiques
  • Artwork
  • Stamps
  • Life insurance
  • Certain types of coins
  • Other collectibles

However, with a self-directed IRA, taxpayers can benefit from expanded asset allocation and invest in gold, commodities, real estate, or privately held companies. A self-directed IRA requires a custodian or financial advisor to manage the account, which usually requires more work for the investor. 

Self-directed IRAs are generally suitable for investors interested in a high-risk, high-return investment. Account holders are still subject to contribution limits and early distribution penalties associated with the traditional or Roth IRA they use. 

4. Rollover IRA

As the name suggests, a rollover IRA is a strategy investors can use to transfer their funds from an employer-sponsored retirement plan — often a 401(k) — to an IRA. This usually occurs when an individual leaves their current job and cannot continue participating in their employer’s plan. A rollover IRA enables investors to avoid penalties or fees associated with early withdrawal. 

If the account holder transfers their 401(k) funds to a traditional IRA, they may not have to pay any penalties or taxes until they withdraw funds during retirement. However, if the funds are rolled over into a Roth IRA, they may incur a tax liability. Investors must deposit funds into the IRA from their employer-sponsored plan within 60 days

5. Backdoor IRA

With a backdoor IRA, taxpayers can convert their traditional IRA into a Roth IRA. Those who use a rollover IRA from a 401(k) into an IRA often use this method to obtain a Roth IRA if they earn too much to open one individually. Investors can contribute to a traditional IRA and convert it to a Roth IRA. However, investors must pay taxes on any funds that have not been taxed up to that point.

A backdoor IRA is not an official IRA but an informal name for Roth IRAs for high-income taxpayers who exceed IRA income limits. As with a rollover IRA, investors who use a backdoor IRA must transfer funds within 60 days.

6. Spousal IRA

A non-working spouse can benefit from spousal IRA if their employed spouse meets eligibility requirements and the couple files taxes jointly.

A non-working spouse can benefit from a spousal IRA if their employed spouse meets eligibility requirements and the couple files taxes jointly. A spousal IRA can be traditional or Roth and will be taxed as such. However, all contributions may be tax deductible if neither spouse has an employer-sponsored plan at work. The employed spouse must still adhere to the annual contribution limit, but it will be doubled to account for both individuals. 

Here’s a quick example — the maximum amount an employed spouse could contribute to their own IRA and their non-working spouse’s IRA would be $13,000 or $15,000, depending on their ages — $6,500 per person if under age 50 or $7,500 per person if older. Of course, the working spouse must also make enough to be able to contribute to both accounts.

Benefits and Drawbacks of Investing in an IRA

Choosing an IRA is an important decision. This investment vehicle has its fair share of pros and cons. Following the rules, limits, and requirements for the IRA you open is essential to receive maximum retirement benefits. 

Here are some of the advantages of an IRA:

  • Tax breaks: IRAs offer tax breaks in some form, but whether you can fully participate depends on your financial circumstances. For example, traditional IRAs are tax-advantaged upfront — you get a partial or full tax deduction the year you contribute. Your contributions are also tax-deferred until you receive your distributions. Roth IRAs are tax-advantaged on your growth and distributions so you can enjoy your withdrawals tax-free.
  • More investment options: Compared to some employer-sponsored retirement plans, like a 401(k), IRAs generally enable you to choose from more investment options. In some cases, you can diversify your IRA with hundreds of investments if you have the funds to do so. 
  • Lower fees: Depending on your plan type, you may benefit from minimized fees for an IRA compared to a 401(k). While this is not true in every case, you may find that advisory fees and some investments through an IRA may be more cost-efficient than with employer-sponsored retirement plans.
  • Flexibility options: A Roth IRA may be better for investors who might want to access their funds earlier. With a Roth IRA, investors can withdraw their contributions — though not any earnings — at any time without penalties since they have already paid taxes on those funds.

Some potential drawbacks to consider when it comes to IRAs include:

  • Penalties and fees: You may take out your money before you reach retirement age, but you will pay a penalty. For example, taking funds out of a traditional IRA before age 59 ½ typically results in a 10% penalty in addition to the taxes you owe on the withdrawals. Withdrawing earnings from a Roth IRA early also results in a penalty.  
  • Inheritance considerations: Various beneficiaries inheriting IRA accounts must follow the required minimum distribution rules according to their relationship with the original account holder. This requirement could mean your beneficiary must empty the account by the fifth year following the inheritance.
  • Contribution and income limits: You need earned income to contribute to an IRA. You must also meet strict contribution requirements and income limits that restrict the amount you can contribute to an IRA or the amount of deduction you can take on contributions.
  • Required minimum distributions: Though required withdrawals from a traditional IRA are not necessarily a risk or disadvantage on their own, you will incur a 25% penalty if you fail to take them. Required minimum distributions start at age 70 ½. Roth IRAs do not have required withdrawals, meaning you can let your funds grow in the account tax-free as long as you live.

How to Open an IRA

Opening an IRA is relatively simple. While the process may differ depending on your specific route, the most important part is doing your due diligence, weighing the pros and cons, and talking to a tax professional. Here’s how to set up an IRA account in a few simple steps:

How to Open an IRA

  1. Choose where to open your IRA: The first step is finding a financial institution where you can open your IRA, such as an investment firm or bank. Be sure to consider the overall services you’ll get, fees, and investment options the institution offers. Determine if your account will be self-directed or managed by someone else. 
  2. Choose your IRA type: Select an IRA that best fits your current and future needs. Consider your income, estimated tax bracket in retirement, and anticipated retirement age. Determine if you prefer to have your tax advantage now or later. This can help you narrow down your options. You can have both a traditional IRA and a Roth IRA, but the contribution limit applies to the total contributed to all your IRA accounts, not per account.
  3. Open your account: You can likely establish your IRA online through your financial institution. Setting up the account will require your personal information and identification, including your Social Security number. You must also name a beneficiary, or heir, to your account.
  4. Make contributions: You can contribute to your IRA through bank transfer, check, or direct deposit. Automatic contributions can help you stay on track with investing and avoid exceeding annual limits.
  5. Invest your funds: The rate of return you receive from your IRA depends on the investments you choose, such as stocks or bonds. You can even decide to invest in real estate through your IRA and generate passive income through a real estate investment trust (REIT).

How to Choose an IRA That Suits Your Needs

If you’re still unsure which IRA is best for your situation, here are a few tips to help you decide.

  • Consider age and income: While you’re never too old to fund an IRA, younger people can generally benefit more from a Roth IRA compared to a traditional IRA. This is because younger people can have their funds grow tax-free for longer. Older people earning more money in their careers may benefit from a traditional IRA by lowering their taxable income and decreasing their income taxes. However, traditional IRAs have required minimum distributions starting at age 70 ½, so planning for those is also important.
  • Consider the five-year rule: You can certainly create an IRA account later in life. However, you cannot open a Roth IRA at age 57, for example, and try to withdraw your tax-free earnings when you hit age 59 ½. Roth IRAs have a five-year rule that restricts account holders from taking out earnings that are not at least five years old. The five-year period begins when you make your first contributions and does not apply to contributions after that.
  • Determine if your employer plan restricts you: If you have a 401(k) or other employer-sponsored plan through your job, it may restrict the contributions and tax deductions you would normally receive through an IRA. This also depends on your income.

Investing in Real Estate Using Your IRA

It’s possible to use your self-directed IRA to purchase investment properties to build a diversified retirement portfolio. These cannot be personal properties. Because property values generally do not fluctuate with the stock market, having real estate through your IRA can make your portfolio more resilient in market downturns.

Investing in certain types of real estate, such as REITs and other income-producing avenues, can also help you generate passive income in a tax-advantaged way. In some cases, you can defer taxes on your real estate earnings and IRA contributions until you withdraw them, such as in a traditional IRA.

All income and expenses must go through your IRA. For example, if you invest in a REIT, which receives rent, the REIT pays dividends into your IRA. Using an online platform like 1031 Crowdfunding, you can access IRA-eligible investments like REITs that may fit your investment goals. 

Learn More About IRA Investing With 1031 Crowdfunding 

An IRA can be a valuable source of income when you retire, as well as a way to diversify your portfolio and access new investments. With different IRA account types and several investments to choose from, it’s best to consult a tax professional to help you narrow down which investment vehicle fits your unique goals and needs. At 1031 Crowdfunding, we aim to simplify complex investing for our clients by providing a state-of-the-art online marketplace where you can view various real estate investment offerings in one place. 

Our professionals are ready to assist you with alternatives for gaining a consistent source of passive income. We can also guide you to IRA-qualified investments you may be eligible for. To learn more about how we serve our clients, register for an account today or check out our blog for investing resources. 

Learn More About IRA Investing With 1031 Crowdfunding

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