What Kind of Investment Account Should I Open And Why?

Estimated read time: 5 minutes

Starting an investment account can seem like a daunting task, especially when you are new to the investment game. You have to be aware of the different costs, minimums, and penalties that you might have to pay depending on your choice.

It's a lot like choosing a credit card because there are so many different options. You can make the right choice for you, however, if you can understand what's out there.

Investment Account Types

There are essentially three different types of accounts that you can open when it comes to investing. Understanding the differences between the types will help you decide which investment account you should open. Here are the various types of investment accounts that are out there for you to choose from.

Individual Retirement Accounts

There's two types here, the traditional and Roth IRAs. Both have tax benefits and are a great way for you to start on your goal for saving for retirement. There are some rules around how much you can invest and when you can take your money out without paying a penalty. Here's a breakdown of both options:

  • Traditional IRA – With this type of investment account, you can save for your retirement and defer the taxes you pay on the growth of your investments. That means that you won't pay taxes until you withdraw your money.

While this is a great tax benefit, you need to be aware of the rules there are with a traditional IRA. For one, you can only contribute up to a certain amount per year into these accounts. Refer to the IRS guidelines to understand what that maximum amount is.

You must also receive taxable compensation and be less than 70-and-a-half years old to invest. This compensation according to the IRS can include commissions, salary, wages, self-employment income, combat pay, and alimony.

Additionally, you will have to pay a penalty or fine if you decide to withdraw money from your account before you are 59-and-a-half years old. There's also a 10% tax on any amount that you withdraw when you withdraw earlier than this minimum age. Once you reach the age of 70-and-a-half, you are also required to withdraw a minimum amount each year from your account. If you fail to meet this requirement, then you will be looking at paying penalties.

  • Roth IRA – These are similar to traditional IRAS with the exception that they allow investors to contribute money they've already paid taxes on. This means you can withdraw your money without having to pay taxes. You won't be able to deduct your contributions to your Roth IRA when tax season rolls around due to this.

There are also maximum contribution amounts that you can invest every year with a Roth IRA. You will want to check the IRS guidelines for the amounts that you are allowed.

Similar to traditional IRAs, you will also have to pay a 10% tax penalty when you withdraw your money before you're 59 and a half. With a Roth IRA, there's also an extra requirement that you have to wait at least 5 years from the time you made your first contribution before you can withdraw. There's not a minimum distribution requirement with a Roth IRA.

Employer Sponsored Plans

Employers will often offer retirement investment accounts to their employees as an added perk for working there. These types of plans have the same types of tax benefits you find with the IRA accounts. Here's the three types of employee sponsored plans that you probably come across:

  • Roth 401(k) and Traditional – It's very common that employers offer a 401(k) plan where the employee contributes a percentage of their salary into the account. The employer will run the investment account on the employee's behalf and chose the types of investments to make in the plan. The employee will have the choice of how to invest their money.
  • SIMPLE IRA – SIMPLEe stands for "Savings Incentive Match Plan for Employees" and allows employees to make contributions to a traditional IRA which the employer has set up. There are no administrative or operating costs which makes them a good choice for small employers.
  • SEP IRA – A "Simplifed Employee Pension" IRA will enable employers to make contributions to a traditional IRA on their behalf. Businesses of any size can use these types of accounts and there aren't any costs to starting or operating them.

Taxable Brokerage Accounts

These types of accounts don't offer tax benefits like IRAs or employer sponsored plans. The benefit is they also don't have to answer to all the rules and restrictions those types of accounts do. There are two types of brokerage accounts:

  • Individual Taxable Brokerage Account– This type is opened by a single person. It holds assets like stocks, bonds, and derivatives. You will have to pay taxes on your gains here, and they will vary based on whether the investment was long-term or short-term.
  • Joint Taxable Brokerage Account– As they name implies, these accounts are shared by several people, most often spouses. The taxes paid will vary depending on the relation between the people who open the account.

You may want to consider a taxable account if you're looking for more flexibility than an IRA or employer sponsored plan can offer. The main benefit here is being able to withdraw the money in the account at any time without a penalty.

Choosing the Right Investment Account for You

The first thing you need to consider when starting an investment account is your individual needs. Consider how much money you have to invest because in most cases a broker will require a minimum amount.

You also need to decide the type of assets you want to get involved in. Aside from stocks, there are also exchange-traded and mutual funds, which can greatly vary. If you plan to focus on stocks, consider what you need to know about buying stock that you may need from a service perspective, such as educational tools.

Getting into the actual types of accounts that are available, you should consider ones that offer a match on your contribution or a tax benefit when possible. A 401(k) that's offered by your employer is a good starting point, particularly when you are a new investor. These plans don't offer a whole lot of options, but that actually makes it easier when you are just starting out.

A good investment account for you to choose from an employer is one that specifies a target retirement date. Those types of funds give you a mix of stocks bonds, and other options that don't need much or any management from you. If your employer matches a percentage of your contributions than you should at least invest that amount.

Consider opening an IRA if you don't have an employer that offers retirement plans. There's the traditional or Roth IRA for you to choose from that offers tax benefits. You also have more flexibility with the types of investments you can choose from than what you find with an employer sponsored plan.

If you believe (which is typically the case) your tax rate at retirement will be higher than it is now, a Roth IRA is a great choice. This is because it allows to contribute your money at your current tax rate and withdraw your money later without having to pay taxes.

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