There are many different types of investment accounts where you can deposit your money. Tax-free, tax-advantaged, tax-deferred, traditional — with so many different options it can be overwhelming to decide where you should invest your money. In this article, we will walk through 5 different types of investment accounts that you should have. Note that we are not talking about checking or savings accounts here. It is smart to keep a few months of savings in a liquid account for an emergency fund. But with interest rates so low, money that earns 1% or less annually is likely losing money to inflation.
401(k) or similar retirement account
The first investment account that we’ll talk about is the 401(k) plan. Most employees have access to a 401(k) through their company. Some companies do not offer these plans, while some public-sector employees use a 403(b) plan and self-employed people have access to a SEP IRA. These plans all work in a similar fashion — money that you put in does not count as taxable income, and you pay taxes when you withdraw the money.
The real magic with a 401(k) plan is that many employers offer a way to match funds that you contribute. Sometimes they will match 100% of any funds you contribute, up to a certain level, and other times companies will match a portion of your contributions. If your employer has a 401(k) match, you definitely want to contribute to your 401(k), at least up to the point where you get all of the free money your employer will contribute.
Individual Retirement Account (IRA)
Another investment account that will help you save for retirement is an Individual Retirement Account or IRA for short. There are two main types of IRAs — a Roth IRA and what is typically referred to as a Traditional IRA. These two types of accounts both can help you save money for retirement but work in slightly different ways.
A traditional IRA works in a similar fashion to a 401(k). Any money you contribute usually does not count towards your taxable income, and you will pay tax on the contributions and earnings once you withdraw it. In a Roth IRA, you pay taxes this year on any amount that you contribute. But then when you retire and withdraw from your account, you don’t have to pay taxes on any contributions or earnings. This makes it a great investment plan for young people or others who are in a low tax bracket. Both a traditional IRA and a Roth IRA are subject to income and contribution limits.
529 College Savings plan
A 529 College Savings plan is a way that you can save for college and other higher education expenses. 529 plans are typically offered by individual states as a way to save for future education expenses. You don’t have to contribute to the 529 plan of the state where you reside, but there are often state tax benefits if you do. Money contributed to a 529 plan is similar to investing in a Roth IRA – you contribute with after-tax money. Then, as long as you use it for qualified educational expenses, you can withdraw the principal and any earnings without having to pay tax on it.
Health Savings Account
A Health Savings Account (HSA) is a way that you can pay for qualified medical expenses with tax-free money. An HSA actually has three different tax advantages:
You can deduct contributions on your taxes
You can withdraw your money tax-free (when used for medical expenses)
Your earnings grow tax-free
You do have to be enrolled in an HSA, you have to be enrolled in an eligible high-deductible medical insurance plan, but the advantages of contributing to and investing in an HSA are hard to ignore. In fact, if you have the means to pay for your current medical expenses, it can make sense to do that and let the money in your HSA continue to grow tax-free.
Standard brokerage account
The final type of investment account that we’re going to talk about is a standard brokerage account. There aren’t any tax advantages with a standard investment account — you don’t get a tax benefit on any money that you contribute and you pay tax on any earnings when you sell.
You should invest in any options you have that have tax advantages first, but if you hit any income or contribution limits, a standard brokerage account can make a lot of sense. That way your investments have a better chance of keeping pace with inflation.
The bottom line
There are several different places that you can invest your money. It’s important to invest your extra money in more than just a checking or savings account earning barely any interest. That is a surefire way to have your purchasing power eroded by inflation. You will want to focus your investment in accounts that offer tax advantages, but any money left over can be invested in a standard brokerage account.