There are various types of investment accounts available for investors. Each type is designed to cater to different investment goals, tax considerations, and investor preferences.
Read over these common types of investment accounts so you can get an idea which ones are best suited to your situation.
Keep in mind that you may have your hands tied with your employer, but that doesn’t mean you can’t open a separate account for yourself.
Types of Investment Accounts
Traditional Individual Retirement Accounts
Also known as Traditional IRAs. These IRAs provide individuals with a structured and tax-efficient way to save for retirement, encouraging disciplined long-term saving habits.
It’s easy to see why this is one of the most common types of investment accounts used for people who want to defer tax implications and wait until retirement to begin making withdrawals.
Pros
- Tax incentives: Contributions are tax-deductible, and investment earnings grow tax-deferred until withdrawal in retirement. Withdrawals are then taxed as regular income.
- Access to a wide range of investment options.
- Spousal IRA option: So you can contribute to a spouses even if they aren’t working,
- Employer independence: Not tied to an employer, so there are no headaches if you change jobs.
Cons
- Annual contribution limits, which is prohibitive for those looking to save more aggressively.
- 10% early withdrawal penalties if taken before the age of 59½
- Required Minimum Distributions (RMDs): It’s mandated that individuals start taking RMDs at age 72.
- Limited tax deductibility for high earners
Roth Individual Retirement Accounts
Also known as Roth IRAs. These IRAs provide individuals with an alternative structured way to save for retirement, encouraging disciplined long-term saving habits.
Roth IRAs contributions are made with after-tax dollars, and withdrawals in retirement are tax-free, including the investment earnings.
Pros
- Tax advantages offer tax-free growth, allowing tax-free withdrawals in retirement.
- Access to a wide range of investment options.
- Contributions (not earnings) can be withdrawn penalty-free at any time.
- No Required Minimum Distributions (RMDs).
- Spousal IRA option: So you can contribute to a spouses even if they aren’t working.
- Employer independence: Not tied to an employer, so there are no headaches if you change jobs.
Cons
- Annual contribution limits, which is prohibitive for those looking to save more aggressively.
- 10% early withdrawal penalties for any interest gained if taken before the age of 59½.
401(k) Plans
Employer-sponsored retirement plans are typical accounts offered to employees. Contributions are typically made on a pre-tax basis. These come in Traditional and Roth options. The Roths have incentives similar to the Roth IRA above.
Pros
- Tax incentives: Contributions are tax-deductible, and investment earnings grow tax-deferred until withdrawal in retirement. Withdrawals are then taxed as regular income.
- Employer contributions: Many employers offer matching contributions, where they match a percentage of the employee’s contributions to the plan. This “free money” and should always be taken advantage of.
- Higher contribution limits than IRAs and 403(b) plans.
- Diverse investment options.
- Employees can typically roll their account over if they change jobs.
Cons
- Limited investment control since some plans have restrictions on investment choices.
- Higher fees than other types of accounts.
- 10% early withdrawal penalties for any interest gained if taken before the age of 59½.
403(b) Plans
Another employer-sponsored retirement plans are typical accounts offered to employees. Contributions are typically made on a pre-tax basis. These come in Traditional and Roth options. The Roths have incentives similar to the Roth IRA above.
Pros
- Tax benefits: offer tax-deferred growth with pre-tax dollars, reducing the current taxable income.
- Employer contributions: Some employers provide matching or non-elective contributions.
- Annuity options may be offered.
- Catch-up contributions: Employees aged 50 or older can make additional “catch-up” contributions.
Cons
- Limited investment options compared to 401(k)s and IRAs.
- 10% early withdrawal penalties for any interest gained if taken before the age of 59½.
- Vesting periods: Some employer contributions may be subject to vesting, which means you need to stay with the employer for a certain period before gaining full ownership of those funds.
Brokerage Accounts
This is a standard investment account that allows individuals to buy and sell a wide range of investments. You have the most options with this type of account.
There are no contribution limits, but capital gains and dividends may be subject to taxes. Some brokerages offer joint accounts if that’s something you’re interested in.
Pros
- Access to a wide range of investment options.
- Convenience and ease of use.
- Access to professional guidance through brokerage tools, resources, and even financial advisors.
- Liquidity and control
- Tax efficiencies like the ability to use tax-loss harvesting to offset capital gains and the flexibility to manage capital gains and losses strategically.
Cons
- Potential fees and commissions for maintenance, trades, and funds.
- The ability to make emotionally fueled decisions in an instant.
- Potential for losses if you’re invested in riskier assets.
- Lack of FDIC Insurance, unlike with bank accounts.
SEP IRAs
SEP IRA stands for Simplified Employee Pension Individual Retirement Account. These are retirement accounts for self-employed individuals and small business owners.
Pros
- Tax efficiencies like the ability to use tax-loss harvesting to offset capital gains and the flexibility to manage capital gains and losses strategically.
- Easy to establish and maintain.
- High contribution limits calculated as a percentage of income.
- Flexible contributions for owners and staff.
- Tax benefits since contributions are tax-deductible.
Cons
- Mandatory contributions for employees if an employer contributes to their account.
- No catch-Up contributions unlike 401(k) plans.
- Need to be self-employed or a small business owner.
Solo 401(k)s
This is a type of retirement account for self-employed individuals and small business owners.
Pros
- High contribution limits calculated as a percentage of income.
- Flexible contributions for owners and staff.
- Permit owners to take loans from the account.
- No requirement for employee contributions like with the SEP IRA.
Cons
- Complex administration headaches.
- Not all types of businesses are eligible.
- Higher administrative costs.
Other Less Types of Accounts
I’m going to go into less detail on these because they’re less common and not ideal for my type of investing strategies. But you may be able to make them work if you’re willing to figure things out.
If you want an option for a child’s account, check out the custodial account option. It has the asset options and control of an individual brokerage account with the incentive of lower children’s tax rates.
Health Savings Accounts or HSAs
A tax-advantaged account, but only for individuals with high-deductible health insurance plans.
Contributions are tax-deductible, and qualified withdrawals for medical expenses are tax-free, but these accounts have limited contributions and heavy penalties for non-qualified withdrawals.
HSAs aren’t ideal for active investing or volatile markets because of the potential need to use the funds to pay for medical costs. You would need to focus on more stable priced assets.
529 College Savings Plans
These are state-sponsored plans designed to help families save for future education expenses. Contributions grow tax-free, and withdrawals are tax-free when used for qualified educational expenses.
These have high contribution limits which can be ideal if family wants to make sizeable contributions to child’s education. They also have a five-year gift tax averaging option.
However, these types of accounts only allow you to invest in portfolios that hold a combination of mutual funds. These plans have penalties for non-qualified withdrawals and withdrawals may affect eligibility for financial aid.
Custodial Accounts (UTMA/UGMA)
Uniform Transfers to Minors Act (UTMA) and Uniform Gifts to Minors Act (UGMA) accounts allow parents or guardians to hold assets on behalf of a minor until they reach the age of majority in their state.
These accounts have a lot more investing control and a wide variety of assets to choose from. You can withdrawal at anytime, but there will be penalties if it’s a non-qualified purchase.
One of the significant benefits of custodial accounts is the potential for tax advantages. The first $1,100 of unearned income is tax-free for the minor. The next $1,100 is taxed at the child’s tax rate. Any income beyond $2,200, is taxed at the parent’s rate.
Annuities
Annuities are contracts with an insurance company that provides regular income payments in exchange for a lump sum or periodic contributions.
They may have tax-deferred growth and a death benefit, but can also involve high fees, surrender charges, and withdrawal penalties. Annuities aren’t very liquid, have limited options, and can be really complex.
Due to their fixed payment structure, they may not keep pace with inflation which reduces their purchasing power over time.
Cash Management Accounts or CMAs
This is a hybrid account that combines elements of checking, savings, and investment accounts which can be convenient. They offer higher interest rates on cash compared to a traditional savings account and are FDIC insured.
CMAs have access to a range of investment options, but you can’t achieve the level of investment returns that you can through a brokerage account. They also have fees and minimum balance requirements.
To Sum Things Up
These are the most common investment accounts, but there may be other specialized accounts available depending on your country’s financial regulations and offerings from financial institutions.
You will have to review the options and choose which accounts line up with your preferences and goals. Maybe you want to have two; one for retirement and one brokerage account.
It makes sense to invest in a retirement account if your employer is matching contributions or you don’t plan to use the funds until you’re past the penalty age. Retirement accounts do have tax-deferred advantages.
I personally like the flexibility, control, and ability to withdrawal from a self-managed brokerage account if needed. You can minimize capital gains taxes by implementing various strategies that we’ll go over later.
