We’re here to help. But before we explore the most common types of investments, let’s first define the containers, or accounts, that hold them. For example, you may have a retirement account, like a 403b or 401k. The 403b is not the actual investment, it is the container that holds them.
Here are some of the most common types of accounts you should know about.
401k and 403b’s are commonly provided “employer-sponsored qualified” accounts. The term “qualified” means that the account receives some level of tax-preferred treatment. Generally speaking, 401k’s are offered by for-profit employers, while 403b’s are offered by non-profit entities.
What makes employer-sponsored retirement plans so unique and so attractive is that they typically allow you to make pre-tax contributions. This enables you to significantly increase the amount you can invest, as taxes have not been withheld. Another advantage for you is that the investments grow tax-deferred, so you will not have to pay taxes on the growth of these investments until you begin to withdraw them.
Many of these plans also offer employer matches, employer stand-alone contributions, and profit-sharing contributions, all of which increase the value of your accounts. We highly recommend that you take full advantage of these additional benefits.
You may also choose to establish your own individual retirement plan. There are many different types to consider, including ROTH and Traditional IRA’s for individuals, and SEP and Simple IRA’s for those that are self-employed. The advantage of an IRA is that your investments typically grow tax-deferred.
IRA’s have strict rules on how much you can contribute each year and if those contributions are tax deductible. You can learn more about IRA contributions and requirements here.
Another account type that gets tax-preferential treatment is a college savings plan. On a federal level, the most common account type is a 529 plan. However, many states offer unique tax-advantaged accounts for their residents. Like retirement accounts, monies in college accounts grow without being taxed, subject to withdraw and account specific rules. What’s more, withdrawals from college savings plans for qualified educational expenses are not taxed on the federal level at all.
Investment and brokerage accounts are containers in which you can hold cash or make investments. Your bank, credit union, or investment firm can help you set up one of these accounts. It’s important to note that unlike some of the other options we’ve explored, these accounts are not tax-advantaged, which means when you sell an investment, your capital gains or losses will be taxed.
When you look at the investible dollars you have for retirement, you should always start with your workplace plan and then leverage an IRA account. However, if your goal is to retire before age 59 ½, an IRA is not ideal, as there are usually tax penalties for withdrawing funds from a retirement account prior to that age.
When you think of investments, a bank account probably never crossed your mind. But, if your risk tolerance is very low and your time horizon is very short, then a bank account may best suit your needs.
Consider this example: For the last several years, you’ve been investing toward a down payment on a house. Now, you’re actively house hunting and want to buy in the next six months. Your short time horizon won’t likely withstand the expected ups and downs in the market. Even though your risk tolerance had been more growth-oriented, your short-term time horizon dictates that you should remove all risk, subject to applicable FDIC limits.
With a bank account, you’re safe from all fluctuations the market might experience.
As an investor you’ll need to make the choice as to which account type is right for you, which will be determined by the purpose for the investments within that account, your personal goals, your risk tolerance, and your time horizon.
Next Up: Understanding Investment Types
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