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ETF Specialist

Starting Your IRA With ETFs

Our third article for young ETF investors highlights the benefits of using an IRA.

Exchange-traded funds are excellent tools for young investors, a group that has unique investment needs and circumstances. The under-30 crowd's investable capital is relatively small, necessitating cost minimization at every opportunity. The investment goals for responsible young people are both short- and long-term: They must begin to save for retirement, even as major expenses like graduate school and home ownership lurk around the corner. Although investing within an individual retirement account may seem incompatible with these near-term needs, an IRA is in fact a logical and straightforward place for young investors to park an ETF portfolio.

IRAs allow investors to grow their assets tax-deferred or tax-free. There are two structures to choose from: a traditional IRA or a Roth IRA. Contributions to a traditional IRA may be tax-deductible and grow from year to year without accruing taxes. Investors covered by an employer-sponsored retirement plan lose the ability to deduct contributions from their taxes at certain income levels, but the real benefit to an IRA is the ability for investments to grow within the account without paying taxes on gains from year to year. Withdrawals from the IRA account during retirement are taxed at the investor's ordinary income rate. Roth IRAs flip the tax schedule: Contributions are made after income tax has been paid, but withdrawals during retirement are not taxed and the account grows tax-free. An investor can contribute up to $5,500 to a Roth IRA every year, as long as his or her modified adjusted gross income does not exceed $125,000. Investors can buy and sell a variety of investments, including ETFs, within either type of IRA without realizing capital gains or paying tax on distributions.

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