Which investment account is right for me?

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If you’re on your own for retirement (you don’t have an employer-sponsored plan), it can seem overwhelming. Where do you open an investment account? How much must you contribute? What is an IRA and Roth IRA? Many people forgo opening an account because it’s too overwhelming. There are too many terms and requirements that they give up.

This guide puts an end to the confusion and shows you how to get started.

Saving for Retirement – The Types of Accounts

Here’s where the confusion starts. Anyone can save for retirement. It doesn’t have to be a designated retirement account. It could be your savings account or a CD (but we don’t recommend that). If you want aggressive earnings that compound, you want a brokerage account, whether taxable or tax-advantaged. Here’s the difference.

Taxable accounts – Anyone can open a taxable investment account. Even people with little money can start. Online discount brokers and micro-investing apps make it easy to invest as little as $5. This is a ‘cash account.’ You may use the funds any time without penalty, and you’ll pay taxes as you cash in your investments.

Taxable margin accounts – Experienced investors with at least $2,000 to invest may invest on margin (aka borrow money to invest). Like a secured personal loan, you use assets already in your portfolio as collateral. You may borrow up to 50 percent of the asset’s price, contributing the other 50 percent yourself. You pay the loan back with interest.

Tax-advantaged accounts: Retirement accounts are tax-advantaged either when you contribute or when you withdraw funds. It depends on the account you open (traditional IRA or Roth IRA). Either way, you get tax benefits and earmark your money strictly for retirement. If you withdraw the funds early, you’ll pay a 10 percent penalty plus pay any tax liabilities. 

Understanding IRA and Roth IRA Accounts

Taxable investment accounts have few restrictions. You open the account, make earnings, and do what you want with the funds. There aren’t any tax advantages; you pay taxes on your capital gains as you withdraw funds.

If you protect your investments in a tax-advantaged account, you must follow the rules, which means less access to the funds until you’re at least 59 ½ years old. A retirement fund is for long-term investing and is why the IRS offers tax advantages, making it easier for investors. 

Traditional IRA 

Investors may contribute up to $6,000 in a traditional IRA ($7,000 if you’re over 50)

You get a tax deduction in the year you contribute the funds, reducing your taxable income accordingly. 

Your earnings grow tax-deferred. You pay taxes on the amount you withdraw according to your tax bracket at that time (Many investors hope they’re in a lower tax bracket during retirement, reducing the tax burden of their income and earnings)

Roth IRA

Investors may contribute up to $6,000 in a traditional IRA ($7,000 if you’re over 50)

You don’t get a tax break when you contribute the funds; the contributions are after-tax. Your earnings grow tax-free.

To learn more about IRAs, check out official government web site. https://www.investor.gov/additional-resources/retirement-toolkit/self-directed-plans-individual-retirement-accounts-iras

The Difference Between Taxable and Tax-Advantaged Investment Accounts

Taxable and tax-advantaged investment accounts have a few differences. Obviously, the main difference is how taxes are handled, but there are a few other key points to consider:

You can’t use investments in an IRA or Roth IRA to offset capital gains in a taxable account 

All money you withdraw from a traditional IRA gets taxed at the current tax rate

If you withdraw funds early (before age 59 ½) from a traditional or Roth IRA, you pay a 10% tax penalty 

You can’t use a margin account to trade in retirement accounts (only taxable investment accounts)

Most retirement accounts only allow stock, bond, and ETF trades (a select few allow options)

What Type of Retirement Investment Account Should you Open?

It seems confusing – which retirement investment account is right for you? What if you have an employer-sponsored 401K? Can you still open an IRA or Roth IRA?

Ask yourself the following questions to choose the account that’s right for you:

Do you have a 401K at work? If so, talk to your tax advisor about your eligibility for tax deductions on additional retirement account contributions. Your modified adjusted gross income determines if you’re eligible. Even if you aren’t eligible, if you have the funds to invest for retirement, don’t let the tax deduction hold you back.

Do you need the tax deduction today? If you’re trying to offset high tax liabilities, a traditional IRA contribution may help. Remember, you’ll owe taxes when you withdraw the funds in retirement, so plan accordingly. Your tax advisor can help you determine what your tax bracket may look like in retirement based on what you have saved/invested thus far.

Do you want to lower your tax liabilities during retirement? If you’re more concerned about your tax liabilities during retirement, consider the Roth IRA. You’ll pay your standard taxes today, but get the benefit of even your earnings growing tax-free. This means more money in your pocket during retirement, a time when most of us need it the most.

The most important factor is that you save for retirement. Whether it’s in a taxable account because you don’t qualify for a retirement account or don’t want the withdrawal restrictions or a full-blown retirement fund, the earlier you start the better. 

It takes time for earnings to grow. The more time you can leave your money to grow (and your earnings to compound), the more money you’ll have in retirement. Pay attention to the tax benefits and your needs, but focus on the bottom line – setting yourself up for a comfortable retirement without the stress of reverse mortgages, relying solely on Social Security income, or taking out personal loans. 

What’s next?

Okay, I got an account open. What’s the right investment for me? We got you covered, go to our investment guide and finish a quick assessment and get matched with a portfolio or investment service.

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