Wednesday, 1 December 2021

5 Types of Investment Accounts to Consider

5 Types of Investment Accounts to Consider
18 Feb

If you’re planning to invest your hard-earned money, you’ve already made the tough choice. After all, it’s not always easy to put money away for tomorrow when there are so many things to spend it on today.

Determining just how to invest those funds, however, can be overwhelming. There are numerous options, and unfortunately there’s no perfect formula for investing success. The best thing you can do is evaluate your options and select the ones that have the most potential to help you meet your unique financial goals. To help, here’s a look at some of the most popular types of investment accounts you may want to consider.

Popular types of investment accounts to consider

1. 401(k) plans

It’s never too early to start saving for your “golden years,” no matter how far away they may seem. One of the most common ways to do so is through a 401(k) plan.

These employer-sponsored accounts let you regularly invest a portion of your paycheck into a portfolio of investments that you choose from the plan’s offerings, including stocks, bonds and mutual funds. Your contributions are typically deducted automatically from your paycheck, so it’s an easy way to set and forget your investment. In some cases, your employer may even offer matching funds.

There are two primary types of 401(k) plans: traditional and Roth. A traditional 401(k) plan allows you to invest money where it will grow tax-deferred until you reach retirement. In the case of a Roth IRA, however, you pay taxes on your contributions upfront, so when you withdraw money in retirement it’s yours tax-free. While there are various considerations when choosing between the two, in general, if you’re in a lower tax bracket now than you expect to be in retirement (often the case for those early in their careers), then the Roth option may be worth exploring.

The amount you can contribute to a 401(k) is capped each year. For example, the total limit for 2019 is $19,000 for both Roth and traditional 401(k)s combined ($25,000 if you’re 50 or older). There are also penalties if you withdraw funds before you reach age 59 and a half or if the account is less than five years old.

2. Individual retirement accounts (IRAs)

IRAs offer another effective way to save for retirement. They’re often a good option if you’ve maxed out yearly contributions to your 401(k) and want to invest more, or if your employer doesn’t offer a 401(k) plan. IRAs can be opened through a bank or broker.

While there are numerous types of IRAs, the two most common are traditional and Roth IRAs. Both come with tax benefits similar to those of 401(k)s. With a traditional IRA, taxes are deferred until retirement, when you’ll be responsible for paying them. Wth a Roth IRA, you pay taxes on your contributions upfront and then you can withdraw money tax-free in retirement.

The contribution limit for IRAs is lower than 401(k)s. For 2019, the limit is $6,000 ($7,000 for those over age 50), though there are some income guidelines that may further limit the amount you can contribute. You may incur penalties if you withdraw funds from your IRA before the age of retirement (59 and a half) or before the account is five years old. However, you can make penalty-free withdrawals if you use the money for certain expenses, such as the purchase of a first home or qualifying education costs. For this reason, IRAs may offer more flexibility than 401(k) plans in some cases.

3. Taxable brokerage accounts

Say you’ve maxed out your retirement plan contributions and are looking to invest even more, or perhaps you want access to the returns on your investments before retirement. In those cases, you may want to consider a taxable brokerage account.

Brokerage accounts serve as a holding place for your investments, including things like stocks, bonds and mutual funds, and you can buy, sell and trade your assets through them. There are no tax benefits, but use of the funds in a brokerage account isn’t limited and can be accessed at any time, for any purpose without penalty. There are also no contribution limits, so you can invest as much as you like in one.

However, there may be some hoops to jump through. Some brokerage firms require a minimum investment to set up an account. They also will likely charge brokerage, transaction and management fees. If your balance drops below a set minimum, you may incur additional charges as well. You will also be responsible for paying taxes on any growth of the funds, including interest earned.

You can either open an individual brokerage account or a joint brokerage account with another person, such as your spouse.

4. Education accounts

If you have children or are thinking about having them one day, then you want to start saving for their education as early as possible. There are a number of accounts that offer a convenient way to do so with tax advantages to boot.

Some to consider include the following:

  • 529 plans: One of the most popular ways parents save, these “qualified tuition plans” include both prepaid tuition plans and general education savings. The rules for use vary by plan, but as long as you use the funds for education expenses, 529 plans can be quite flexible and offer a convenient way to save and grow funds tax-free.
  • Coverdell education savings accounts: Coverdell accounts are similar to 529s in that they provide tax-free savings for education. While the contribution limit for Coverdells is significantly lower ($2,000 per year), they typically offer more investment choices for your funds.
  • Custodial accounts: Also known as Uniform Gifts to Minors accounts (UGMAs) or Uniform Transfers to Minors accounts (UTMAs), these custodial accounts are brokerage accounts that are set up for minors. They can be used for education or any other purpose as long as it’s for the child.

5. Micro-investing accounts

If you don’t have a ton of cash to invest, you may want to consider a micro-investing account. These come in various forms, but often work through an app on your phone. One popular type invests the “spare change” from your daily purchases. For example, if you buy groceries for $33.25, your purchase would be rounded up to $34 and 75 cents would be invested. Over time, those small amounts can add up significantly, and you likely won’t even miss them.

How to choose the right account for your money

As you can see, there are options aplenty when it comes to investment accounts, all with differing benefits and limitations. To choose the best one for you, make sure you look closely at the details, including the minimum amount necessary to invest as well as any associated account fees. While in many cases the fees are simply withdrawn regularly from your account, high fees can add up significantly over time. You also want to take into account any matching funds that an employer may offer in the case of a 401(k) and the tax benefits of some accounts.

Beyond the details, make sure you consider your unique financial goals and circumstances, including how much risk you’re willing to take. Make sure to revisit your accounts regularly so you can adjust your selections appropriately if your life circumstances or goals change.

Investing is far from an exact science, but the potential for payoff is certainly there. Consider your options, diversify when possible and seek professional assistance if necessary.

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Julie Ryan Evans


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