Types of Investment Accounts
This article outlines the main types of investment accounts. Put some thought into what your investment goals are and choose the best account for your purposes. Happy investing!
By Kaitlin Meyer — April 26, 2023
One step to investing for the first time is choosing what type of investment account you want to open. While seemingly a simple step, many options exist regarding types of investment accounts.
Taxable Accounts
Taxable investment accounts, or standard brokerage accounts, provide access to stocks, bonds, mutual funds, and more. They also allow you full control over your portfolio — you can choose what and how much to invest. This creates an opportunity for you to tailor your investments to be the most profitable. If you invest in a 401(k), for example, only certain stocks and funds are allowed to invest. These accounts are more flexible than others and have fewer restrictions. This comes with a tradeoff: they do not offer tax breaks, as many other accounts do. Taxes are collected on the income you deposit, and any capital gains made are taxed during the tax year in which they enter your account.
The main reason to invest in a taxable account is liquidity: you can withdraw money at any time and use it for any purpose. Retirement accounts only allow withdrawals after you turn 65, education savings accounts require money from the account to go towards tuition or educational expenses, and other investment accounts have similar restrictions. You may use a taxable investment account to save for retirement or education. Suppose you have invested as much as possible in your retirement account but still want to save money. Or you may want to set aside money for educational expenses that might not qualify under a 529 investment account. These are just some of the uses of a taxable investment account.
You can open a taxable investment account through a financial advisor or an online brokerage—research stocks, funds, bonds, or whatever you are interested in investing in. You may also use a robo advisor to help you make selections on your online account. A robo-advisor is an automated piece of software that analyzes stocks and other investments and recommends what to purchase.
Retirement Accounts
There are two main categories of retirement accounts: Roth and traditional. Roth accounts tax money that goes into the account but allows you to withdraw money tax-free during retirement. Traditional accounts will enable you to invest money tax-free but require you to pay taxes on money taken out in retirement. Both of these options are desirable in different situations. For example, invest in a Roth retirement account early in your life and career when you do not have as much yearly income and will not pay very high taxes. On the other hand, you may invest in a Traditional retirement account later in your career when you are pulling in a high yearly income. This yearly income will likely be larger than what you withdraw yearly during retirement, making it advantageous to pay taxes on the back end.
There are several types of retirement accounts that you can open in different circumstances: an employer's 401(k), a solo 401(k), a 403(b), a 465, an IRA, a SIMPLE IRA, a SEP IRA, and a few others. Most of these can either be Roth or traditional. An employer's 401(k) is a retirement account provided by your employer. You can usually choose to contribute a portion of your salary to this account. You do not get to choose what stocks, funds, or other things to invest in.
A solo 401(k) is an investment account you can open independently. People generally choose to invest in a solo 401(k) if their employer does not have one or they are self-employed. The 403(b) and 465 retirement accounts are provided for employees of non-profit businesses and are very similar to 401(k). An IRA is an individual retirement account not associated with a workplace. You can open an IRA on your own and can choose from a variety of different investments. The steps for opening an IRA are similar to those for taxable investment accounts: your financial advisor can open one for you, or you can open one through an online brokerage. SIMPLE and SEP IRAs are retirement account options for small businesses, with different rules for employer and employee investments. There is no Roth option for SIMPLE IRAs. Your employer can give you the details on these last two types of retirement accounts.
Investing in your employer's 401(k), or whichever retirement account they have available, is one of the easiest ways to start investing, as the account is already set up, and all you have to do is put some money in it. An IRA has a few extra steps, such as opening the account through a brokerage and choosing investments. There are fewer options to sort through regarding what to invest in than open taxable investment accounts. Opening a retirement account is an excellent choice for your first investment account.
Education Investment Accounts
Education savings accounts, such as the 529 or the Coverdell Education Savings Account (ESA), are investment accounts that allow you to save for education. These can be education for yourself or, more commonly, for your children. Withdrawals can be used for educational expenses related to elementary, secondary, and higher education. These accounts allow money to be withdrawn tax-free and require that money be spent on tuition or other qualified educational expenses.
The 529 plan and the Coverdell Account, or ESA, are the two main educational investment accounts. Anyone can open a 529 account, and anyone (friends or family) can contribute to it regardless of who opened the account. You do not need to make a certain amount of money or more than a certain amount of money to open a 529 account. In addition, 529 accounts allow you to deposit more money per year than other educational accounts. Lastly, 529 accounts only allow withdrawals of $10,000 each year. SAGE Scholars offers more information on how to open a 529 account. ESAs are a little more restrictive than 529 accounts because only couples with an income less than $220,000 can open an account, and only $2000 can be contributed yearly. In addition, the account must be liquidated before the beneficiary is 30. ESAs offer more investment options than 529 plans and do not have a cap on yearly withdrawals.
Health Accounts
Health investment accounts are investment accounts that are used for healthcare expenses. These generally allow you to invest money tax-free, and withdrawals can be made to pay for qualified healthcare expenses. Paying for healthcare expenses with tax-free money can lower the cost of medical expenses.
The two most common investment accounts for healthcare expenses are the Health Savings Account, or HSA, and the Flexible Spending Account, or FSA. To open and contribute to an HSA, you must have a High Deductible Health Plan (HDHP). You can use the HSA to help pay for medical expenses anytime, even if you do not have an HDHP. Qualifying expenses include deductibles, copayments, and coinsurance, among others. An FSA is an account sponsored by your employer to cover qualifying healthcare expenses. This functions more like a traditional savings account than an investment account. Employees can contribute up to $2850 annually, and any money not spent on medical expenses at the end of the year goes to their employer.
Bonus: Investment Accounts for Kids!
Several investment accounts listed above have alternative forms for children or can be set up for minors. For minors who earn an income from a part-time job, there are custodial IRAs. The parent opens and manages the account until the child turns 18, and then the account rolls over to the child. As mentioned above, 529 accounts and ESAs can be opened for children. These accounts contribute to their educational expenses. There are also trust and brokerage accounts designed specifically for children or teens. Brokerage, or taxable, accounts give full ownership to the child and do not require a parent to act as custodians. While children should be monitored and make investment decisions with their parents, this can be a great way of getting them interested and encouraging them to learn about investment at a young age.
This article outlines the main types of investment accounts. Put some thought into what your investment goals are and choose the best account for your purposes. Happy investing!
Kaitlin Meyer
Kaitlin Meyer is a Master's student at Ohio State University (OSU), and is writing a thesis on snow microstructure inspired by her love for skiing. She earned a B.A. in Liberal Arts from Wyoming Catholic College (WCC).
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