Investing in the future is always a smart move, but that doesn’t mean deciding where to invest your money is easy.
In fact, it is complicated. There are more than 30,000 mutual funds, more than 8,000 individual stocks — and tens of thousands of financial advisors more than happy to charge you fees to help figure it all out.
Since different types of investment accounts come with different benefits and tax treatments, it’s important to understand how each one works and who it’s good for.
This quick guide was created to explain the types of investment accounts available and why you might want to consider them.
Be sure to check out our robo-advisor reviews for robo-advisors we've worked and partnered with at Wealthy Single Mommy.
Related: How to start investing for women
Let's dig into this topic
- Types of investing accounts for 2018
- Employer-sponsored plans
- Investing accounts for the self-employed
Types of investing accounts for 2018:
- Individual Retirement Accounts (IRAs)
- Employer-sponsored plans
- Investing accounts for the self-employed
- Taxable brokerage accounts
- College 529 savings accounts
- Which investment account is best for you?
Individual Retirement Accounts (IRAs)
Individual Retirement Accounts, also referred to as IRAs, offer a way for consumers to save for retirement in place of, or in addition to, another retirement account like a 401(k).
Different IRAs come with different tax treatments and different rules on who can contribute, however.
A Traditional IRA lets you save money that will grow tax-deferred until you reach retirement age. This means that you put money in now, depending on your income level, you may be able to deduct the amount you contribute to a Traditional IRA (up to annual limits) to reduce your taxable income that year.
Individuals younger than 70½ can contribute to a Traditional IRA. For 2018, you can contribute up to $5,500 to all IRA accounts combined if you are under the age of 50 or $6,500 if you’re ages 50 and older.
Since this type of account is for retirement, you cannot withdraw money without penalties until you’re at least age 59½.
Required minimum distributions are also required on these accounts by April 1st of the year following the year you turn age 70½.
If you or your spouse do not participate in a retirement plan at work, your traditional IRA contribution is fully deductible up to your contribution limit, which is based on your income.
You can contribute to a Traditional IRA if you earn less than these limits in 2018:
- $73,000 for individuals
- $121,000 married, join returns
- $189,000 married, filing separately
A Roth IRA works differently than a traditional IRA since you contribute after-tax dollars to this account.
The same $5,500 limit applies for those under the age of 50 (or $6,500 if you’re ages 50 and older) across all your IRA accounts.
Since the funds you contribute are made with after-tax dollars, the money also grows tax-free and can be withdrawn on a tax-free basis once you reach retirement age.
As an added bonus, you are able to withdraw your contributions to a Roth IRA account at any time without penalty (though you would have to pay taxes on any profits earned).
Keep in mind that income requirements apply, and many high-income individuals and couples cannot use a Roth IRA.
In 2018, phase-outs for Roth IRA contributions start at:
- $120,000 for singles
- $189,000 for married couples filing jointly
- Phase out completely at $199,999 for married couples and $135,000 for singles
While this option is dwindling, many employers still offer investment benefits to employees.
Some of the main employer investing plans include:
Traditional and Roth 401(k)
If you work for someone else, you may have access to a 401(k) plan. With this type of plan, employees contribute a certain percentage of their wages and may even receive a “match” of some of those funds from their employer.
The money contributed to a traditional 401(k) is added to your account on a pre-tax basis up to annual limits, and this will reduce your taxable income for the year.
From there, your money grows tax-free, and you don’t pay income taxes on it until you begin taking withdrawals during retirement.
For 2018, employees can contribute up to $18,500 to these accounts. If you’re ages 50 and older, however, you can contribute up to $24,500 ($6,000 more) each year.
Like with a traditional IRA, there are penalties to pay if you need to withdraw money from your 401(k) before you reach age 59 ½.
When it comes to Roth 401(k)s, these investing accounts work similarly to Roth IRAs in the fact you contribute to them with after-tax dollars.
However, with a Roth 401(k), required minimum distributions start at age 70 ½ and there are no income limitations.
While many employers offer their workers a 401(k) plan, Roth 401(k)s are a less popular option.
It is important to note that employers who do offer a Roth 401(k) are also required to offer a traditional 401(k).
A Simple IRA (Savings Incentive Match Plan for Employees) is another type of employer-sponsored plan that is even less common than the Roth 401(k). This type of plan is often offered by small employers but is also used by the self-employed.
With a Simple IRA, employers are required to make either matching contributions or nonelective contributions to the plan.
In the case of matching contributions, the employer may match the employee contribution for up to 3% of the employee’s salary.
With nonelective deferrals, the employer makes contributions to the plan whether the employee contributes or not.
Like other plans, contributions made to a Simple IRA are tax-advantaged up to certain limits.
Money then grows tax-free and is taxed once you begin taking distributions in retirement.
Like other plans, you’ll need to pay a penalty if you need to take money out of your Simple IRA before age 59 ½.
Investing accounts for the self-employed
If you’re not employed by a traditional employer or you own a business, consider investing accounts for the self-employed.
While other retirement accounts can be used by self-employed individuals (e.g. traditional and Roth IRAs), the high limits of self-employed investing accounts make them a smart option when it comes to saving money to fund retirement.
The main investing accounts for the self-employed include:
A SEP IRA (Simplified Employee Pension) allows self-employed people, freelancers, and small business owners to save for retirement in a tax-advantaged way.
The contributions you make to this account cannot exceed either a) 25% of compensation, or b) $55,000 in 2018. However, employees of a small business owner cannot contribute to this account; only the employer can contribute up to 25% of their salary up to annual limits.
These accounts are often considered the best for self-employed workers and since there are minimal start-up or operating costs and contribution levels are so high.
Like other investment accounts, however, you’ll pay a penalty if you need to take money out of your SEP IRA before age 59 ½. Required minimum distributions also start at age 70 ½.
A Solo 401(k) plan, also known as a sole participant 401(k), is another requirement plan perfect for freelancers and individual business owners.
This type of plan can cover a business owner with no employees or the business owner and their spouse.
There are two ways individuals can contribute to these plans — first as an employer and second as the employee.
On the employee side, individuals can contribute up to an annual limit ($18,500 in 2018). On the employer side, you can also contribute up to 25 percent of compensation as defined by the plan as long as the total contribution doesn’t exceed $55,000 for the year.
So, if you are like me and the owner and sole employee of a company, you can contribute the full $55,000, assuming your company's income allows for it.
Best to check with your tax professional.
Once again, you should plan to pay a penalty if you need to withdraw money from your Solo 401(k) before age 59½.
Required minimum distributions are also required starting at age 70 ½.
Taxable brokerage accounts
While the investing accounts described above are mostly intended for retirement savings, there is another type of account to invest money in for retirement or other goals: taxable brokerage accounts.
You can open up an individual taxable account or a joint account with a spouse or partner.
Taxable brokerage accounts offer a path to continue investing even after you have “maxed out” traditional retirement accounts that may have tax advantages.
The best part about taxable brokerage accounts is the fact that there is no limit to how much you can contribute as well as no limits on income.
Taxable brokerage accounts are for anyone who wants to grow wealth beyond what they can accrue in a traditional retirement account.
Also, keep in mind that taxable investing accounts may offer more ways to invest your money than a traditional account like a 401(k).
Where your employer may limit funds or options to choose from, a taxable investing account lets you invest your money how you want.
This could mean trading stocks, investing in bonds, or buying index funds, but it’s your choice.
Since taxable investing accounts are offered irrespective to your employment, you’ll need to open an account on your own.
Fortunately, you can open a taxable brokerage account online through a variety of firms like Vanguard, Scottrade, or Fidelity or use a robo-advisor to start investing.
College 529 savings accounts
Many parents, grandparents and others choose to invest in a 529 plan to help pay for the education of a child in their lives. There are pros and cons to 529s. One of the biggest mistake parents make is actually investing too much in their children's future education, neglecting their own retirement and other long-term financial planning.
Remember: There are countless ways that young people can finance and pay for their college educations (including paying for it themselves!). But there are no loans or Pell grants for retirement.
If you are on tract with your investments, have at least 3 months in cash in a savings account, are maximizing your employer's 401k or other retirement match, have your personal debt easily managed, and feel comfortable that you can retire comfortably, then consider investing in your child's future. Here is what you need to know:
What is a 529 plan?
A 529 plan is a federal program that allows for tax advantaged savings and investing for education. Any profits from a 529 plan accumulate tax-deferred, and you do not pay federal taxes on any distributions when you use them for qualified higher education expenses, which now include accredited colleges and universities, computers, and up to $10,0000 for K-12 private education.
How does a 529 plan work?
Almost every state has its own 529 plan. You can invest in any state's 529 plan, and use your investment for any one of the more than 6,000 U.S. colleges and universities, as well as 400 schools in other countries, that are considered eligible.
In many states, you can deduct your 529 investment from your state taxes. In all cases, any gains from your investment are tax-free, as long as you use the money to pay for college.
If your child named on the account does not use the money for any reason, your investment can be transferred to another family member without penalty, or saved for a graduate school — so long as the funds are used for qualified educational purposes. Unused funds can be withdrawn for non-education purposes, subject to federal taxes and a 10% penalty.
To successfully use a 529 plan:
- Open a 529 college savings plan. You can start a 529 plan with CollegeBacker, a platform that helps connect families with the tools and resources they need to finance higher education.
- You choose which investment fund you want to manage your money, putting you, the investor, in control of the investment. CollegeBacker keeps an updated list of the best 529 college savings plans.
- Contribute when and how you like — occasionally as you have extra cash, with automatic monthly depositions, and/or in gifts from loved ones at birthdays and holidays.
- When it comes time to withdraw the funds (in a lump sum, or as-needed), fill out your program's withdrawal forms, and distribute to the beneficiary (child) — not the account owner.
Which investment account is best for you?
Most us are better off taking advantage of tax-advantaged retirement accounts first.
While a pre-tax retirement account like a 401(k) or Traditional IRA can help you save money on taxes now, a Roth IRA can help you save money on taxes later.
Choosing either (or both) of those options is likely a smart move to make first.
On the flip side, taxable investing accounts are ideal for people who have a lot to invest and want some control over how their cash is allocated.
At the end of the day, taking a holistic look at your finances and financial goals is the best way to determine which type (or types) of investing account would leave you better off.
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Holly Johnson is a financial expert, award-winning writer, and Indiana mother of two who is obsessed with frugality, budgeting and travel. Her personal finance articles have been published in the U. S. News, Wall Street Journal, Fox Business, and Life Hacker. Holly is founder of of the family finance resource, ClubThrifty.com, and is the co-author of Zero Down Your Debt: Reclaim Your Income and Build a Life You’ll Love. Learn more about Holly here.