Filing your taxes can be overwhelming, which is the reason most people hire financial advisors to help them. However, once you understand how taxes work, you can start looking for ways to reduce the money you pay.
Maybe retiring is not in your mind yet, but it’s good to know you have retirement savings to rely on once you do. The best way to save money for the future is to open a traditional or Roth IRA. They both give you more ways to manage your taxes but require you to pay different fees.
It’s essential to understand those fees to avoid making any mistakes when you pay taxes or manage your accounts. It may seem like an unnecessary expense to not only pay taxes but also pay for the annual account maintenance fee most companies ask you to pay, but doing so lets you enjoy all the benefits IRAs hold for you when you retire.
Regardless of that, there are several ways of reducing the fees you have to pay on IRAs, and we are here to teach you how to do it. Dive into this page to learn everything you need to know about traditional and Roth individual retirement accounts!
What Will I Learn?
- Overview of Traditional and Roth IRA
- The Concept of IRA Fees
- Deep Dive into Traditional IRA Fees
- Deep Dive into Roth IRA Fees
- Strategies to Minimize IRA Fees
- Tax Implications of IRA Fees
- Frequently Asked Questions
Overview of Traditional and Roth IRA
Understanding Traditional IRA
The first thing you should know about traditional IRAs is why they are called like that. This type of retirement account was the first to ever exist, and it came from the US government in 1974. People call it a traditional retirement account to tell it apart from other types of IRAs that came after it.
If you were to call these accounts differently, you could call them “conventional IRAs” or “pre-tax IRAs,” but we recommend you stick to their common name. Traditional retirement accounts let you save pre-tax dollars and make your contributions tax-deductible the year they are made.
When you have a traditional IRA, money grows tax-deferred until it’s withdrawn. Then, you can tax them as ordinary income. Nonetheless, there is a limit to the contributions you can make to the account each year, and withdrawing money before being 59 and a half years old has penalties.
Here is an example of how traditional IRAs work: Let’s say you make a $6,000 contribution to the account with a 25% tax rate. In this case, you can deduct $6,000 from your taxable income and save $1,500 in taxes. Now, let’s imagine your investments get to $100,000; when you withdraw that money in retirement, you’ll owe income tax on the full amount of money you hold in the account.
Understanding Roth IRA
Roth IRAs are different from traditional ones, and they started 20 years after the first type of IRA. Its goal is to offer Americans different ways to manage retirement savings.
In a nutshell, Roth IRA advantages lie in allowing people to save after-tax dollars, so their contributions are not tax-deductible the year they make them. The money that grows in Roth IRAs and its withdrawals are tax-free, but the account has income limits. Similar to traditional retirement accounts, you will have to face penalties if you withdraw money before the age of 59 1/2.
Let’s change the example we made about traditional retirement accounts and make it about Roth IRA contributions. If you contribute $6,000 to a Roth IRA, you won’t get a tax deduction for it, which means you will owe income tax on the full amount of money you get. Regardless of that, if your investments grow to $100,000, you won’t owe any taxes on the money you withdraw.
Key Differences Between Traditional and Roth IRA
Opening a traditional retirement account is 100% different from opening a Roth IRA. The difference between Roth and Traditional IRAs is how you tax them. When using the former, you get tax-deductible contributions you will pay when you withdraw them, while the latter offers tax-free withdrawals but lacks tax-deductible contributions.
Traditional IRAs don’t have income limits, and Roth retirement accounts do. Your Modified Adjusted Gross Income (MAGI) determines if you are eligible to open a Roth IRA.
However, Roth IRAs lack limitations you’ll face with traditional individual retirement accounts. An example of that is required minimum distributions (RMDs). While you don’t use RMDs when working with a Roth IRA, traditional accounts ask you to take them when you turn 72.
Which option is better for you? It depends on what your investment goals are. People in a higher tax bracket who want to get to a lower tax bracket when they retire should go for a traditional retirement account. On the other side, individuals in a lower tax bracket who expect to be in a higher one in retirement will benefit more from a Roth IRA.
The Concept of IRA Fees
Investors need to pay IRA fees to keep running their individual retirement accounts, but those fees change depending on the type of IRA you choose and the financial institution that manages it. These are the main types of fees you’ll have to pay in traditional and Roth retirement accounts:
Types of Fees in Traditional and Roth IRA
It’s important to know that the fees you pay for your individual retirement account depend on the financial institution they come from. That means that Roth IRAs will charge different fees if you switch the Roth IRA providers you use.
However, both accounts often face similar fees. Below you will find the main fees financial institutions may charge you for an IRA, but you must always hire a financial advisor to help you manage yours to avoid making a mistake along the way.
- Account maintenance fees: Most IRA providers ask for annual or quarterly account maintenance fees to keep your account running. These fees often range from $10 to $50 yearly.
- Transaction fees: You may have to pay a fee each time you make a transaction within your IRA account, depending on your IRA provider. That includes buying or selling mutual funds, bonds, or stocks. Transaction fees are often between $4 and $10 per transaction.
- Investment fees: It’s common for a mutual fund or exchange-traded fund to charge management fees. People know those fees as expense ratios and deduct them from the fund’s assets. These are not similar to account or transaction fees, as they often cost a percentage of the investment. This applies to traditional and Roth IRAs.
- Opening and closing fees: Regardless of the reason, financial institutions may charge a fee for trying to close your IRA. You may also need to pay something when you try to open a new account, whether it’s a Roth IRA or a traditional one.
Another important thing to note is that you can technically trade with your Roth IRA since the IRS doesn’t have any explicit rules against it. However, if you decide to do it, you would have to look for a place that offers commission-free trading if you want to lower your extra expenses.
Costing of Traditional and Roth IRA
The cost of opening and running traditional and Roth IRAs mostly comes from the fees you have to pay. That includes opening, closing, investment, maintenance, and transaction fees. Hence, it’s important to have a financial advisor who tells you what you should and shouldn’t do while managing your account.
If, for example, Roth IRA providers charge transaction fees, you should avoid making too many transactions, as that could make you lose all your retirement money on additional expenses. When a traditional or Roth IRA has investment fees, you need to hire someone who knows how to manage mutual funds, ETFs, and other assets.
The financial advisor you hire should give you an estimate of the total cost your IRA may have, so you can both work to reduce it and keep it from getting higher. They will also help you with the account paperwork and financial planning.
Impact of IRA Fees on Retirement Savings
IRA fees can have a huge impact on your retirement savings if you don’t know how to manage them. If you, for example, have a $100,000 IRA account with a 6% annual return and pay 1% in annual fees, you would have roughly $574,000 after 30 years. Investors with the same amount of money who only pay 0.5% of it in annual fees would have $668,000 by the same time.
We’ll do the math for you; it’s a $94,000 difference. Even if you don’t notice it, small differences in fees can completely change how much money you get at the end of the day, so you have to be extra careful with your financial moves when you manage a traditional or Roth IRA.
Deep Dive into Traditional IRA Fees
Fees for Opening a Traditional IRA
It’s not common for financial institutions to charge a fee for opening a traditional individual retirement account. However, some have other up-front costs you will have to pay right after you create the IRA.
Maintenance Fees in Traditional IRA
Most IRA providers charge maintenance fees yearly, but you can also find some of them doing it quarterly. Sometimes, transaction fees are included in maintenance ones, so don’t get scared if you have to pay more money for it than you thought you would.
However, if it’s only a maintenance fee that doesn’t include transactions, they often range from $10 to $50 a year. When they include transaction fees and commissions, the financial institution may charge you $4-$10 per transaction.
Investment Fees in Traditional IRA
As we mentioned before, investment fees charge you a percentage of the total amount of money in the account. Expense ratios for mutual funds and ETFs often go from 0.05% to 1% or more, but everything depends on the assets you invest in.
Here, financial advisors and investment firms play an essential role. If you see your account has a high mutual fund expense ratio, you should try other investment products, for example.
Fees for Closing a Traditional IRA
Similar to what happens with opening fees, you don’t often have to pay anything to close a traditional individual retirement account. What most people do is transfer their money from one IRA to another. Keep in mind that if the provider doesn’t ask for closing fees, you won’t have to pay anything as long as you do it properly. Making mistakes along the process could have financial penalties.
Deep Dive into Roth IRA Fees
Fees for Opening a Roth IRA
Before taking steps to open a Roth IRA, it is important to note that Roth IRAs don’t typically ask for opening IRA fees so in that case, you may have to make a minimum deposit depending on the provider you choose. Although some people don’t like the idea of being asked for a minimum deposit, it’s better than paying a hidden fee, as it’s money you would use anyway.
Maintenance Fees in Roth IRA
Maintenance fees are often more expensive with a Roth IRA than with a traditional account. It shouldn’t go further than $50, but it’s odd to see it below $25. Regardless of that, it’s fundamental to know that many mutual funds, brokerages, and investment firms avoid charging maintenance fees today.
Investment Fees in Roth IRA
When providers ask for maintenance fees, they sometimes include investment ones within them, so you would only need to pay for a maintenance fee and make the financial moves you want. However, others manage investments the same way traditional IRAs do with mutual funds and other options.
Fees for Closing a Roth IRA
As it happens with traditional IRAs, you are not likely to pay IRA fees for closing your Roth IRA as long as you do it properly. This applies to most types of individual retirement accounts.
Strategies to Minimize IRA Fees
Since IRA fees can have a huge impact on retirement savings, it’s essential to know the right financial moves to minimize them as much as possible. As we mentioned before, a group of small differences can make a big one, so here are a few things you can do to reduce your IRA fees:
Choosing the Right IRA Provider
Not all financial institutions work the same, which means they have different politics and don’t charge you the same fees when you open a traditional or Roth IRA. Choosing the right IRA provider is a great start, so we recommend you research and compare the fees your options offer.
You won’t find a provider that doesn’t charge fees, but there are many with little to no maintenance and transaction fees, for example. It’s important to take a look at all the benefits they offer for the money you have to pay; if they have a decent balance, it may be a deal worth trying.
Investing in Low-Cost Options
Investment fees can take a lot of money from your IRA, so you should look for low-cost investment options. Index funds and ETFs often have lower expense ratios than other assets, such as mutual funds.
Avoiding Unnecessary Fees
Remember when we told you to check out the benefits each provider offered for the fees it charged you? Well, not all of the benefits financial institutions offer are that necessary. If you don’t need features such as paper statements, don’t go for providers that charge you for them. Everything should be in the fine print the financial entity shows you.
Comparison of IRA Fees Across Providers
Since not many providers charge closing and opening fees for a traditional or Roth IRA, you should actively compare yours to others to see if you are really getting the best deal. You can do that research yourself by checking online or asking your financial advisor to do it. Regardless of that, if you see that another provider offers something better, you should evaluate the possibility of switching to it.
Tax Implications of IRA Fees
The relationship between taxes and IRA fees can make the fees better or worse. They change depending on the type of IRA you choose, and understanding them can help you pick one or the other. Here, you can read more about the matter:
Tax Treatment of Traditional IRA Fees
Any fees related to the administration or management of your individual retirement account should be tax-deductible when talking about traditional IRAs. That includes account maintenance, transaction, and investment advisory fees. However, if you make an investment that makes tax-exempt income, fees related to it won’t be tax-deductible. That often happens with municipal bonds and similar assets.
One of the main benefits of opening a traditional individual retirement account is that most of its fees are tax-deductible, which makes it way easier for you to minimize them. If you don’t want to worry that much about fees, then you should go for traditional options instead of a Roth IRA.
Tax Treatment of Roth IRA Fees
Contrary to traditional IRAs, the fees of a Roth IRA are not deductible since its contributions come from after-tax dollars. Regardless of that, fees can still alter the growth of a Roth IRA and reduce the number of tax-free distributions you get when you retire.
Impact of Fees on Tax Deductions
As we mentioned before, knowing how to manage your IRA fees-taxes relationship can help you optimize how you manage your individual retirement account a lot. Let’s say you itemize your deductions on your tax return. Doing that might let you deduct your IRA fees along with other expenses, which will make you spend less money on taxes when the time comes.
On the other hand, if an investor tries the standard deduction methods instead of itemizing them, it will be more difficult for them to deduct their IRA fees. Consider these things before choosing between a traditional or Roth IRA.
Frequently Asked Questions
What Are the Average Fees for a Traditional IRA?
Traditional IRAs often have an annual account maintenance fee that ranges from $10 to $50. While some financial institutions include financial expenses in that annual fee, others charge from $4 to $10 for each transaction you make within the IRA. The same happens with the expense ratios of mutual funds and other investment options.
It’s not common to see a traditional IRA having closing or opening fees, so you shouldn’t worry about them. Regardless of that, you may have to face financial penalties for not doing the process correctly. Most people also pay additional fees, such as the financial advisory one.
What Are the Average Fees for a Roth IRA?
Similar to traditional accounts, you may not have to pay any fee to open or close a Roth IRA, and some providers don’t even charge a maintenance fee. Therefore, some people only need to pay transaction, financial advisory, and investment fees when they go for this option.
Regardless of that, it’s common for providers offering a Roth IRA to ask investors to make a minimum deposit before they open the account. That could also happen with traditional individual retirement accounts, but it’s easier to see it in Roth ones.
Do All Investments in an IRA Carry the Same Fees?
The short answer is no. All assets have different expense ratios, which means you will have to pay a different fee for them. Most people recommend trying investment products with low expense ratios, such as EFTs, since mutual funds and municipal bonds are often more expensive. The ratio may also change depending on the type of individual retirement account you have.
If you want to make it simpler, people looking for low-cost investment options should always try indexed products. Being low-cost doesn’t mean being a bad option for your portfolio, as they are often popular with value-conscious investors looking forward to saving as much money as they can.
How Do IRA Fees Impact My Retirement Savings?
IRA fees can significantly impact your retirement savings if you don’t manage them correctly. People think they are not that expensive when they see they only have to pay $10 a year, for example, but they are missing the big picture. You will have to pay for that for decades, and that only adds up to the other fees the IRA may have.
An investor who optimizes how they manage their financial fees could even save up to $100,000 compared to one who doesn’t care about it and only pays for it. The idea of opening a traditional or Roth IRA is to have as much money as you can when you retire, so no one should let fees take that money away from them.
Can I Avoid Paying Fees on My IRA?
No one can avoid paying fees on their individual retirement accounts since, even if some providers don’t offer the same features others do, they still charge you for their services. What you can do is organize your financial moves to reduce the fees you have to pay.
The more you understand how IRA fees work, the more you can reduce the amount of money you will lose from either a traditional or Roth IRA after paying its fees. While this could seem like a lot of work, it will pay off once you see how much money you save for retirement.
You will be okay as long as you hire a decent financial advisor. However, remember to choose the right provider, try low-cost options, avoid paying for things you don’t need, and always try to look for better options to make sure you are always getting the best deal out there. If you want to read more blog posts about IRAs, you will find more on our website, so check it out now!