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You can invest money in many different kinds of accounts. Read on for three accounts to explore, so you can decide which ones are right for you.
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When you first begin investing, it’s smart to start with the most accessible account available to you. For many people, this is a workplace 401(k) plan. It’s best to contribute enough to your 401(k) to earn the full amount of any employer matching contribution provided by your company, if one is provided. A 401(k) is easy to sign up for by completing some paperwork at work, your contributions are made with pre-tax dollars, and if your company matches your contributions, you get free money.
After you’ve put money into your 401(k), though, you most likely will want or need to open a brokerage account to keep investing. There are many different options for account types and you should understand the ins and outs of each before you decide which one(s) to open. For many people, it makes sense to have several, because they can help you achieve different goals.
Here are three types to consider.
1. Traditional IRA
A traditional IRA is a brokerage account you can open to save for retirement. Here’s how a traditional IRA works:
You can claim a tax deduction for money you contribute to your IRA, up to annual limits. The annual contribution limit is an aggregate limit with Roth IRAs (mentioned below).If either you or your spouse has a workplace retirement plan, there are income limits to make tax deductible contributions.You will pay taxes on withdrawals from your account as a retiree.You can invest in pretty much any asset your brokerage account offers.You will be required to take required minimum distributions (RMDs), which are distributions the government mandates once you reach age 72 or once you turn 73 if didn’t turn 72 by Dec. 31, 2022.If you withdraw money before age 59 ½, you will have to pay a 10% penalty in addition to your ordinary income taxes on the distributed funds.
An IRA can be an ideal investment choice if you think your current tax bracket is higher than it will be in retirement. It can help you save on taxes right now.
2. Roth IRA
A Roth IRA is another tax-advantaged retirement account you can open with a brokerage firm to help you save for your future. Here’s how it works:
You do not get to claim a tax deduction for money you contribute to a Roth IRA in the year you make the contribution.You are allowed to make contributions up to the annual limit, which is a combined limit with traditional IRAs.You cannot contribute to a Roth IRA if your income is too high.You can withdraw funds tax free in retirement as long as you comply with certain rules (like making sure you’ve had the account open for at least five years).Distributions from your Roth IRA won’t count when the government determines if you make so much money that your Social Security benefits should become partly taxable.You can invest in pretty much any asset your broker offers.You are not required to take RMDs, no matter how old you are.You can withdraw your contributions anytime, but must pay a 10% penalty if you withdraw gains before 59 ½.
A Roth IRA can be an ideal choice if you think your tax bracket will be higher as a retiree so you want to defer your tax savings, if you don’t want to have to take required minimum distributions, or if you are worried your investment income in retirement will be high enough that Social Security payments are taxed.
3. Taxable brokerage account
A taxable brokerage account doesn’t come with the same tax breaks that retirement plans do but there are other benefits. Here’s how it works:
You pay taxes when you sell assets in this account at a profit. You can deduct losses.You may be taxed at your ordinary income tax rate if you are subject to short-term capital gains taxes (because you owned the asset for a year or less).You can be taxed at a more favorable capital gains tax rate if you owned the asset for a year or more (your capital gains tax rate is either 0%, 15%, or 20%, depending on income).You can invest in any asset your brokerage account offers and even do things like trade on margin (borrow against your assets to get more money to trade).You can withdraw money whenever you want. You don’t have to wait until you’re a certain age or use the funds for retirement.
A taxable brokerage account is a good option if you’re saving for long-term goals other than retirement, or if you have already exhausted your tax-advantaged retirement accounts and still want to save more.
Once you’ve maxed out your 401(k), it’s time to consider the pros and cons of each of these three options to decide where your money should go next. You may just find you want to open a few of these account types, and that’s a perfectly OK choice too.
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