No matter what investing strategy you follow, it’s important to diversify your portfolio as much as possible. Opening multiple investment accounts spreads the risk around rather than concentrating all the risk into one account, limiting your losses in a market downturn. These are some of the most common investment accounts available to help you reach your goals.
Qualified vs. Nonqualified Accounts
Before you start squirreling away as much cash as possible, it’s important to understand the difference between qualified and nonqualified accounts. A qualified account receives preferential tax treatment, which may help you save even more money in the long run. Nonqualified accounts don’t have the same tax benefits.
Common Types of Qualified Accounts
Here are some of the most popular types of qualified accounts.
Individual Retirement Arrangement (IRA)
An individual retirement arrangement, commonly referred to as an IRA, is an investment account used to save for retirement. As a qualified account, the traditional IRA is subject to certain rules regarding how much you can invest each year and how that money is taxed. From 2019 through 2022, the annual contribution limit was $6,000; the IRS announced the limit would increase to $6,500 in 2023.
One of the main benefits of contributing to a traditional IRA is that your contributions and earnings usually aren’t taxed until you start taking withdrawals. If you earn a high salary now and expect to be in a lower tax bracket when you retire, using this type of account can help you reduce the taxes you pay when you’re older. Depending on how much you earn and how you file your taxes, you may be able to deduct your contributions when you file your federal return.
Roth Individual Retirement Arrangement (Roth IRA)
The Roth IRA is also used to save for retirement, but it isn’t taxed the same way. When you invest in a traditional IRA, you use pre-tax dollars and don’t pay income taxes on those funds until you start making withdrawals. With a Roth IRA, you invest post-tax dollars. You can’t deduct your contributions on your federal return, but you also don’t have to pay income tax on your contributions or earnings when you retire.
Another difference between a traditional IRA and a Roth IRA is that you can’t contribute to a Roth IRA if your income exceeds certain limits. For 2022, you can contribute the full amount if you earn less than $129,000 (single, married filing separately or head of household) or $204,000 (qualifying widow(er) or married filing jointly). Depending on how much you earn, you can contribute a reduced amount. If your income exceeds the limit, you can’t contribute at all. Roth IRAs have the same annual contribution limits as traditional IRAs.
Common Types of Nonqualified Accounts
Here are some of the most common types of nonqualified accounts.
Checking Accounts
Checking accounts are technically deposit accounts, but they can also be used for investing purposes. Many banks offer interest-bearing checking options, allowing you to earn money on your deposits. The rates on these accounts are quite low, so you shouldn’t rely on a single checking account to produce a significant return, however.
Savings Accounts
A savings account is another type of deposit account used for investing purposes. Interest rates on savings accounts are a little higher than on checking accounts, but they’re still much lower than what’s available with other types of investments. Opening a savings account is a great way to earn extra money while saving for a rainy day.
Brokerage Accounts
If you want to buy stocks, bonds and other investments, you’ll need a brokerage account, one of the most common investment accounts available. When you open a brokerage account, you deposit funds for investing purposes. If you sell an investment, the proceeds go back to your brokerage account, where you can either reinvest the funds or allow them to earn interest. Brokerage accounts also come with tools and information to help you make wise investment decisions, which can help you maximize your rate of return.
Employer-Sponsored Investment Accounts
Many companies offer employer-sponsored investment accounts as part of their benefits packages. One of the benefits of signing up is that your employer may match some of your contributions, allowing your balance to grow even faster.
401(k) Plans
In 2020, nearly 70% of employees working in private industry had access to some type of retirement plan. Many of these workers participated in 401(k) plans, which are qualified profit-sharing plans that allow employees to have money withdrawn from their paychecks and deposited into an investment account.
Contributions are made with pre-tax dollars, reducing your taxable income while you’re working. Your employer may also contribute to your account, increasing your initial investment and making it easier to take advantage of market growth. Since 401(k) plans are qualified accounts, some restrictions exist. For 2022, the contribution limit was $20,500. The IRS decided to increase the limit to $22,500 for 2023.
457 Plans
Some government agencies and nonprofit organizations offer 457 plans, deferred compensation plans used to help employees save for retirement. These investment accounts have the same contribution limits as 401(k) plans—$20,500 for 2022 and $22,500 for 2023. You don’t pay income taxes on your contributions or earnings until you start taking withdrawals, making a 457 plan a great way to reduce your tax burden when your earnings are at their highest.
403(b) Plans
A 403(b) plan works much like a 401(k) or 457, except it’s only available to certain people, including employees of public school systems, ministers employed by tax-exempt organizations and eligible employees of certain nonprofit organizations. If you participate in a 403(b), you make your contributions with pre-tax dollars and pay no tax on your earnings until you begin withdrawing.
The main difference between a 403(b) and other employer-sponsored investment accounts is that 403(b) plans have much higher contribution limits. In 2023, you and your employer can contribute a combined total of $66,000 or your includible compensation for your most recent year of service, whichever is lower. If you earn $50,000 per year, for example, you couldn’t contribute the full $66,000 since it exceeds your annual salary.
Choosing The Right Investment Accounts
Investing in your retirement early is important, but knowing where to put your money is just as crucial. There are a number of investment opportunities available, so you’ll want to decide which options are best for you. When you can, look for qualified accounts that receive preferential tax treatment, as they could help you save more in the long run. However, regardless of what you choose, diversify your investments to make sure you stay protected in case of a market downturn.
You might also be interested in: 9 Ways To Start Saving For Retirement Now