This is a part II of a four part series on how to get started in investing. Read part one here.

Part II: Individual Retirement Account (IRA)

In part I, I said that participating in a 401k is a good way to start in investing. But once you contribute up to your company’s match, it is not wise to invest more in your company’s 401k, because 401k funds have higher expense ratio or management fee. You also don’t have much control on what to invest in since there are limited number of funds in your plan. Next, you should open an Individual retirement account (IRA).

If you do not get a 401k because your company doesn’t offer one, or because you work part-time, IRA is the best account you have got. As long as you make taxable earning (you don’t necessarily have to pay taxes) you can open an IRA account. For those of you who have a 401k, but don’t get a company match, you also should first fund your IRA to the max, before participating to your 401k.

IRA account let’s you contribute up $5000 per year towards your retirement. A traditional IRA account has no income limitation, but you can only contribute to a ROTH IRA if you make under $101,000 per year (if you file as a single). For those of you who qualify, opening a ROTH IRA is almost always better than a traditional account, because earnings on the account is tax-free and you can take out your contribution anytime after opening your account for five years. If you don’t qualify for a ROTH, congratulations! You are making a lot! But you should still have a traditional IRA account. It’ll save you some on taxes.

There is another type of IRA account that you’ll hear about often, and that is called a rollover IRA. If you participate in a 401k, and then you quit your job, you can rollover your entire 401k amount without paying any taxes or penalty into this rollover account. As I mentioned before, it is not smart to leave your money with your ex-employer, and do not rollover into your new employer’s 401k, because like I said, 401k charge way more fees. It is not good to cash-out either because then you’ll have to pay taxes and a 10% penalty. So every time you change your job, you can rollover your money into this account. You’ll have more control of your money and more investment options.

Remember that the annual limit is a combined contribution on all your IRA accounts, so you won’t get to save more just by opening different IRA account. Rollover accounts do not count towards this max. You have until April 15 of next year to open a IRA account and fund it for this year, so even if you have not made any contribution for 2008, you have plenty of time. Remember that you do not have to contribute all at one time. Once you set up an account (they may have minimum balance to open),  you can set-up monthly investment of $400 or so and in a year you’ll have contributed $5000.

IRA account can be opened at any bank or financial institution. But you should consider how you want to invest IRA money before opening an account. Since you are saving for a retirement which is years away, you should invest your IRA money, just like your 401k money, in stock mutual funds. Therefore, look for a low cost mutual fund company instead of a bank. I highly recommend Vanguard. They have a huge selection of low cost mutual funds, and they do not charge for account maintenance fee like other company do. Most fund have minimum of $3000, but after you are set you can invest as little at $50 at a time.

So to summarize so far, if your employer offers 401k, participate just enough to get the maximum contribution, and then max out your IRA account. If your employer doesn’t offer a match or if you don’t have a 401k option, max out your IRA account first.

In my next post, I’ll talk about non-retirement investing.