Should You Open an IRA at Your Bank?
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Most people have some knowledge about the concept behind an Individual Retirement Account (IRA).
What most people don't know is there are material differences between IRAs offered by banks and credit unions and those offered by investment firms and other types of financial institutions.
Since IRAs offered by banks tend to be less flexible than those available at other providers, it makes sense to have a conversation specifically about the Bank IRA.
With that in mind, the following information is going to focus on the pros and cons of this retirement investment option at your local or online bank.
What is a Bank IRA?
What is a Bank IRA?
There's nothing tricky about this question. This type of IRA is a retirement savings account explicitly offered by banks and credit unions.
Yet, they tend to differ from IRAs available elsewhere in that they offer a lot less flexibility in terms of investment options and provide lower returns.
Other than less flexibility and earnings, a bank IRA operates similarly to other types of IRAs when it comes to contribution limits, tax advantages, and income limits.
They're available under the same IRS guidelines and tax rules as the traditional IRAs offered by other financial firms.
What is an IRA, and How Does It Work?
If by chance, you're not familiar with the traditional IRA concept, you should find the following information helpful.
Most employers with 50+ employees will offer employees access to a tax advantage 401K retirement investment account or an equivalent 403(b).
For many reasons, this is a job perk employees tend to covet, one being the tax benefits.
For employees and business owners who don't have access to a workplace retirement plan or would like to invest more than the annual contribution limits of a 401(k), the Internal Revenue Service (IRS) has devised the IRA.
- IRA vs. 401(k): How they differ and where to invest 1st
- Retirement Plans for Self-Employed: What to choose
A traditional IRA is an investment option that allows participants to invest a portion of their annual income on a pretax basis.
The term pretax basis means that the amount the individual invests will come right off their taxable income before calculating their final tax liability.
Under IRS guidelines, IRA investors can invest limited funds in a wide range of options, including:
- interest-bearing instruments (Certificates of Deposit (CDs), etc.)
- mutual funds
- index and exchange-traded funds
- real estate
- precious metals, etc.
Under additional IRS guidelines, IRA investors are permitted to withdraw their monies at any time.
However, you will get hit with a 10% penalty on all amounts you choose to withdraw before hitting 59 1/2 years of age, with some exceptions noted below.
After hitting that key age, there will be no withdrawal penalties.
Once you hit age 72, you'll need to take the annual required minimum distributions (RMDs) from your Traditional IRA.
Whether you access the funds in your Traditional IRA early or as withdrawals in retirement, you will need to pay income taxes on the withdrawal amount at your applicable tax rate due to obtaining a tax deduction upfront at contribution.
There is a loan carve-out for emergencies. According to the IRS, penalty-free withdrawals may be allowed as loans under the following circumstance:
- To cover emergency medical costs
- To cover higher education costs for offspring or the taxpayer
- A limited amount to be used for the purchase of a primary residence
- To pay a federal tax liability
- For home improvements
- To cover wedding costs
- For the purchase of a primary auto
After taking out an IRA loan, the investor would simply make payments back into their IRA, plus any applicable interest.
The Pros and Cons of a Bank IRA
Now that you have some understanding of how a traditional IRA works, it will be easier to look at the pros and cons of a bank IRA.
Remember, we mentioned that bank IRAs are a bit more limited in terms of investment options and return. In essence, banks tend only to offer IRAs that are tied to CD investments.
Under certain circumstances, a bank may offer other investment options for their IRA investors, mainly focusing on stocks, mutual funds, and bonds. But that list of options is significantly less than those offered by brokerage firms and other financial institutions.
Moving on, here are the pros and cons of a bank IRA.
The primary benefits of securing an IRA through a bank are:
- Fixed and guaranteed rate of return on the investment amount
- The FDIC insures the CD investment for up to $250K. That protects against a bank's default
- CDs require little education about investing
- The investment decision is very easy, especially when its time to renew the CD
- The fixed-rate benefit allows for more precise financial planning going into retirement
- Banks are easier to deal with and tend to require less documentation than investment firms
- It's easy to tie bank accounts and IRAs together within the same bank
Of course, any investment option will come with some negatives or cons. In the case of a bank IRA, the cons are:
- Little to no ability to invest diversely
- Certificate of Deposit rates are typically low, many times significantly lower than most other types of investments. There is an opportunity cost associated with choosing a low-return conservative investment.
- No option for other brokerage services
- Lower returns will result in less financial resources in retirement
Bank IRA – Yes or No?
You now have a general idea about the differences between an IRA you can open at a bank and IRAs available at other financial institutions.
You also have a general idea about the pros and cons of a bank IRA. The question is, how do you decide which option is better for you and your financial goals?
As a general rule of thumb, you should let your current age and expected retirement age play a significant role in how you invest your retirement funds, whether that's within an employer sponsored retirement plan, an online brokerage account, or at your local bank.
If you are under the age of 40, you can afford to take more risks for higher returns. This is true because you would have plenty of time to recover from adverse investment events.
A bank IRA is likely not your best investment option as part of this age group.
If you're in your 40s, you can probably still afford to take some risks, but as you near 50, you might consider opening an IRA with a bank that offers a wider variety of investment options.
This is a good time to start thinking about diversity.
Into your 50s, your current personal financial situation should be your guide. You're running out of time to plan for and meet your retirement goal and might want to get conservative with your retirement investing.
If you are already in your 60s, reading to retire, and have limited resources outside of Social Security, you'll likely want to start tapping into your IRA.
While you do, or if you can let it ride, a bank IRA with a CD investment will protect your retirement resources while still offering you a small return on investment.
After reviewing the pros and cons of utilizing a bank IRA and how it might fit into your financial situation, consider consulting a financial advisor if you're still uncertain about which option you should take.
(You might also want to consult a tax advisor when deciding between the traditional IRA and Roth IRA.)
When in doubt about the future, there's nothing wrong with taking the path with the least amount of risk as you build your nest egg; just remember you might sacrifice a few earnings.
Written by Women Who Money Cofounders Vicki Cook and Amy Blacklock.
Amy and Vicki are the coauthors of Estate Planning 101, From Avoiding Probate and Assessing Assets to Establishing Directives and Understanding Taxes, Your Essential Primer to Estate Planning, from Adams Media.