Investment accounts can be an effective way to secure your financial future and build wealth. They help you grow your money over time, and help you reach your financial goals. Investment accounts can seem a little overwhelming to understand at first—but don’t worry, we’ll break them down for you here, by the various types of investment accounts and how they work. If you’d like to boost your overall investment knowledge, check out our article on Investment terms.
1. Individual retirement accounts (IRAs)
Individual Retirement Accounts, or IRAs, are popular investment products designed specifically for retirement savings. There are two main types of IRAs:
Contributions to a Traditional IRA may be tax-deductible, meaning you can reduce your taxable income for the year you make the contribution. The earnings in a Traditional IRA grow tax-deferred until you withdraw the funds during retirement. When you do eventually withdraw it, you’ll have to pay income tax.
Contributions to a Roth IRA are made with after-tax dollars, meaning you don’t get a tax deduction when you contribute. However, the earnings in a Roth IRA grow tax-free, and when you make qualified withdrawals once you’re retired, those are also tax-free. Roth IRAs offer flexibility, allowing you to withdraw your contributions (but the investment earnings they’ve accrued) at any time without penalties or taxes.
One of the other most popular retirement account types is a 401(k) plan. To learn more about the differences between a 401k plan and IRA plans, check out our article IRA vs. 401k: Understanding retirement accounts.
2. 401(k) plans
A 401(k) is an employer-sponsored retirement plan, usually offered by larger companies. Employees can contribute a portion of their salary to the plan, often with the option for the employer to match a percentage of their contribution. Contributions to a traditional 401(k) are pre-tax, reducing your taxable income for the year. Like a Traditional IRA, the earnings in a 401(k) grow tax-deferred until you retire, and withdrawals are subject to income tax.
3. Brokerage accounts
Brokerage accounts are versatile investment accounts that allow you to buy and sell various types of investments, like stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Unlike retirement accounts, there are no restrictions on when you can withdraw funds from a brokerage account, but you’ll be subject to capital gains tax on any investment earnings when you sell them and cash out.
4. 529 plans
A 529 plan is a tax-advantaged savings plan designed specifically for educational expenses. These plans come in two main types:
College savings 529 plan: This type of 529 plan allows you to invest money for qualified education expenses like tuition, room and board, and textbooks. The earnings in the account grow tax-free as long as they’re used for qualified education expenses.
Prepaid 529 Plan: Some states offer prepaid tuition plans that allow you to prepay future tuition costs at today’s prices. This can be an effective way to protect yourself from rising education costs.
5. Health savings accounts (HSAs)
Health Savings Accounts help you save for medical expenses, especially if you have a high-deductible health insurance plan. Contributions to an HSA are tax-deductible, and the earnings in the account grow tax free. Any withdrawals you make for qualified medical expenses are also tax free. HSAs offer a unique triple-threat tax advantage: tax-deductible contributions, tax-free growth, and tax-free withdrawals for medical expenses.
6. Certificate of deposit (CD) accounts
While not traditionally considered an “investment” account, Certificates of Deposit (CDs) can be a conservative option for growing your money. CDs are offered by banks and credit unions and usually have a fixed interest rate and a specific term. You agree to leave your money with the institution for the entire term, and in return, you receive interest on your deposit. CDs are considered low-risk investments, making them a good choice if you’re looking for a more stable option.
The bottom line: understanding investment accounts
Understanding the different types of investment accounts is a helpful step toward building a diversified and effective investment strategy. Whether you’re focused on retirement savings, covering education or medical expenses, or general wealth accumulation, there’s likely an investment account that matches best with your goals. By leveraging the benefits of these accounts and weighing their unique features, you can make informed decisions to build a strong financial future. Remember to evaluate your risk tolerance, investment goals, and the specific tax implications of each account before making investment decisions. To learn more about investing, check out our article Crash course: investing 101.