By Maggie McGrath (Forbes Staff)
Original post date: 3/04/2014
If you were to gather 100 financial experts, stick them in a room and ask them, “What’s the most important thing people need to do to build sufficient retirement savings?” most would likely offer the same answer: start saving early and do so on a regular basis. Boring? Perhaps, but it’s something a lot of folks need to hear. According to the Employee Benefit Research Institute, just 57% of workers are currently saving for retirement and only about half of workers are even offered a 401(k) or other savings plan by their employer.
That’s why President Obama’s plan to set up a new retirement account – the myRA — is designed for people who don’t have 401(k)s. But here’s the dirty little secret about myRA: it’s not revolutionary. It’s actually a variant of the Roth IRA. (Obama technically can’t be blamed for any lack of creativity: myRA had to be built around existing law. It’s the best he can do by executive order, or without the help of Congress, where his broader proposal for a universal and auto-enrolling IRA sits in purgatory.)
For Millennials and others just starting to save, myRA has a few key selling points: there’s no annual account maintenance fee; you can open an account with as little as $25; additional contributions can be as small as $5 every payday; and, if an employer agrees, savings can be put on autopilot, with contributions deducted automatically from your paycheck, as they are with 401(k) contributions.
As with a Roth IRA, you don’t get any tax break for contributing to myRA, but all money in the account can be taken out tax free in retirement. What’s more, if you need your money sooner – say for an emergency or to go back to school — you can take back your original contributions (but not earnings) at any time, without taxes or the 10% penalty that hits most early withdrawals from traditional pre-tax retirement accounts. As with any Roth, singles with an adjusted gross income of less than $129,000 and couples with less than $191,000 are eligible to contribute. (For more on the advantages of the Roth IRA for Millennials, see Ashlea Ebeling’s story here.)
But myRA has some big drawbacks: It won’t be available to savers until much later this year; all your money will be invested in relatively low yielding Treasury debt; and you can’t build a balance of more than $15,000. At that point, your money must be transferred to a regular Roth IRA offered by a private sector firm.
So instead of waiting for a myRA account, why not set up a Roth IRA on your own now? Turns out, for beginning savers, that’s easier said than done. If you’ve got thousands to deposit at one time, it’s easy to find a no or low fee Roth IRAs offering all sorts of investment choices. (Note that you can put up to $5,500 per person in a Roth IRA for 2013 until April 15th and another $5,500 for 2014, so you could actually plop $11,000 in one of these accounts at one time if you act now. You do have a spare $11,000 sitting around, don’t you?)
But if you want to treat a Roth as a starter account, then you’ll need to pay close attention to minimums and fees, which aren’t always easy to determine. “I think a lot of times, when you tell people to start a Roth IRA, it’s not as simple as doing just that. There are a lot of steps involved. That’s the frustrating thing,” says Sophia Bera, a certified financial planner and founder of Gen Y Planning. “First of all, where? Then, how much do you need? And that’s not something a lot of people talk about, and [minimums] vary at every single place.”
Indeed. To save you the hassle, we spent a good bit of time calling around and clicking through web sites to unearth the best myRA substitutes for beginning savers. Our premise was this: You want to start saving on a regular basis in a Roth right away. You might be content to keep your stash in a low yielding money market to start, but once you’ve got a respectable amount, you’d like to move your funds into something with a better long run return—maybe a stock index fund or an age-based fund that has a mixture of stocks and bonds. So the ideal account would offer a low or no-fee way to start small, a way to make regular small deposits (via automatic transfers from your checking account or even directly from your pay) and low cost stock funds available now, or at least once you’ve built up a reasonable amount and are ready to do some serious investing. (That last part is particularly important, since retirement savers too often open an IRA at tax time, and then leave money sitting in a money market account.)
We found it’s hard to get all those attributes and even harder to compare offerings. For example, the Vanguard Group is known for its low cost index funds, which will save you a bundle in fees over the decades you’re investing for retirement. Problem is, Vanguard won’t open a Roth IRA for you unless you’re able to deposit a minimum of $1,000 and it requires additional deposits be made in increments of $100 or more. John Woerth, a principal at Vanguard, argues account minimums are a way to keep other fees low. “It’s a matter of cost efficiency. Vanguard is known for its low costs [and] small transaction charges,” Woerth says, adding that he thinks $1,000 is a reasonable minimum. “It’s just the cost for T. Rowe Price, or any other company, to service that account. [Savers] need an investment to be above what it would cost to service the account,” echoes Judith Ward, a senior financial planner at T. Rowe Price, which has the same minimums as Vanguard. Charles Schwab also has the same $1,000 minimum to open a Roth, although you can get around it if you have $100 automatically debited each month. (Once you hit a $1,000 account balance, the $100-per-month deposit requirement goes away.)
While there’s no way around the minimum at Vanguard and T. Rowe, as the table below shows, you can get around the $20 account maintenance fee at either mutual fund company by signing up for paperless account statements. So if you’ve got $1,000 saved and are able to automatically deposit $100 a month, these are reasonable options.
At the other end of the spectrum, most credit unions will allow you to open a Roth IRA with that same $25 minimum myRA will have, reports Bill Hampel, chief economist of the Credit Union National Association. “The MyRA is in essence, a formalized version of what most credit unions already offer,” he says. Moreover, if you schedule an automatic transfer from your checking account, or if your HR department allows you to set up an automatic transfer from your paycheck before it hits your checking account, you can have amounts as small as $25 or even $5 per pay period regularly transferred into that credit union Roth – again, much like the myRA. But the yield on these accounts will be low, because your retirement savings will be in a money market account or certificate of deposit that will likely pay less than 1%.
Hampel argues that beginner savers shouldn’t get hung up on the small number in the “rate of return” category. “There is a time to be concerned about rates, but it’s not when you have a really small balance,’’ he says. Problem is, when you are ready to invest in stocks and bonds, you’ll have to do a custodian-to-custodian Roth transfer, which can be a hassle. So keep in mind the power of inertia before you decide to use a credit union.
One alternative is to park your money in a no minimum account that enables you to invest in mutual funds or ETFs once your account reaches a certain size. Fidelity Investments, TD Ameritrade and E*Trade all allow you to open a Roth IRA with any amount for free, and make additional deposits of any size. But to get into a low cost index fund, you still face minimums. At TD Ameritrade, for instance, there’s a $1,000 minimum to invest in a fund like the BlackRock S&P 500 Stock Fund (ticker: BSPAX) and Fidelity has a $2,500 minimum for its Spartan Total Market Index Fund (ticker: FUSEX). While you save up to the minimum, your money will sit in a money market fund earning next to nothing. You won’t face minimums when buying ETFs (basically mutual funds that trade like stocks), but you’ll usually pay a transaction fee (say $4 to $10) for each purchase, making it expensive to invest small amounts each month. (E*Trade offers a list of ETFs, including target-date funds, you can buy commission free and TD Ameritrade offers a similar list. But beware, the expense ratios for such ETFs tend to be high, meaning you’ll end up paying more long term. For example, the transaction fee-free DBX-Trackers 2040 Target Date Fund (TDV) charges 0.65% of assets a year, compared to 0.17% for a Vanguard target date fund.)
One intriguing possibility for those who don’t see themselves as individual stock pickers is the web site Betterment. The site offers a limited number of investments– a portfolio of 12 low cost ETFs, including Vanguard Total Stock Market ETF (VTI), iShares S&P 500 Value (IVE), iShares Core Total Aggregate US Bond (AGG) and Vanguard Total Intl Bd Idx ETF (BNDX). Betterment will help you design a portfolio from these ETFs based on your risk tolerance and will rebalance your portfolio to maintain that asset allocation. There’s no minimum to open a Roth or for additional contributions, and no transaction fee for ETF purchases. But there is an annual asset management fee, which covers all advice and trading costs: 0.35% of assets a year if you have under $10,000 invested and are contributing at least $100 a month; 0.25% if you have at least $10,000 but less than $100,000; and 0.15% if you have an account balance of $100,000 or more. If you have less than $10,000 and are contributing less than $100 per month, you pay a $3-per-month flat fee instead of that 0.35%. (In other words, $36 a year for Betterment services.) That’s on top of the annual expense ratio of the ETF themselves, which Betterment says averages just 0.16% of assets, or 16 cents for every $100 invested.
Another option is CapitalOne’s ShareBuilder, which also lets you open an account for nothing and has no minimum investment or annual fees. ShareBuilder has two options. The first is for those who want to make small, automatic investments, and allows the purchase of partial shares, for a fee of $3.95 per trade, per security. So, if for instance, you’re kicking in $100 per month and one share of your desired investment, SPDR S&P 500 ETF Trust (SPY), sells for $187, you can make the purchase for $3.95. Unlike Betterment, your choice of investments isn’t limited. But if you want to automatically invest in a diversified portfolio of four ETFs (the kind of portfolio you might set up at Betterment), you’ll have to pay four $3.95 fees–or a prohibitive $15.80 for every $100 contribution you want to make to your Roth. If you don’t elect to do automatic investments, than partial share purchases aren’t available and each trade costs $6.95.
Say this for the mutual funds, Betterment, ShareBuilder, TD Ameritrade and E*Trade: the fees are out there for you to compare. That’s not necessarily the case with the big banks. When I called one bank, (which shall remain unnamed) and asked how much it costs to open a Roth IRA there, the answer went something like this: “well you click here, find Roth IRA, click ‘more information’… oh. It’s not there. Strange.” PNC is one bigger bank that allows you to open a Roth for no money down and slowly build your balance in a money-market-type account until you’re ready to invest in something meatier, but finding that out required more digging. (To their credit, at least it’s findable at all.)
It’s worth noting that Betterment and Sharebuilder are entirely online affairs, so if you’re the type of person who requires a brick and mortar branch, you’ll want to weigh that against the other benefits of using either service. E*Trade, despite its name, does offer brick and mortar locations, which you can find using their branch locator tool. TD Ameritrade, too, despite being largely online also offers brick and mortar branches (not to be confused with TD Bank branches).
Once you’ve chosen an investment house and portfolio that fits your needs, the next important step you need to take is to automate the savings process so you don’t have to think about it every month. One way to do that is to schedule an auto-transfer from your checking account. But if you’re really afraid you’ll spend the money once it hits your checking account, you can ask your employer’s human relations department to transfer a set amount each paycheck into your Roth IRA account. Moneesh Arora, senior vice president and general manager of payroll processor ADP’s retirement services division, said that this should be possible at any company using ADP as its payroll processor; however, to find out if you can get an auto-deposit from your paycheck, it’s best to check with your own HR department.
It’s worth the extra effort, says Brandon Potter, vice president of product management at Sharebuilder. “For better or for worse, we found that customers that set up the auto enrolment through their workplace stick to the plans more than people who do it through their bank account. It’s a lot harder to walk to your HR manager and ask to shut it down,” Potter says. “We think of it as a hidden benefit – it makes it a little bit harder for people to not save.”
Adds Shiyan Koh, vice president of personal finance management for NerdWallet, “I think the big thing for consumers to remember, really, the more ways they can help themselves save in an automated way, the better off they’re going to be in the long run.” NerdWallet offers its own online screener that assesses online brokerage options, like E*Trade and others, which is worth testing if you’re committed to the idea of using an online brokerage and want to make absolutely certain you’re on top of exactly how much your IRA will cost you.
Above all, one of the biggest savings mistakes you can make— aside from not saving at all – is to just go with the name of a familiar bank or brokerage without looking into just what it will cost to open and maintain that account. “I think you shouldn’t necessarily think that the bank you’ve banked with all your life is going to give you the best deal,” Koh says, stressing the importance of doing research and comparing options. “As a consumer, the best thing you could do is minimize fees at the outset.”