Like a fine wine, your investments should get better with age. And it’s important to find the right pairings. Once you’ve set a goal, it’s time to pick the right account to help you get there.
What kind of goals are we talking about?
Retirement. Because working forever probably isn’t at the top of your to-do list. Here are some popular options:
401(k): A retirement account you get from work. With a traditional 401(k), you won’t pay taxes until you cash out. Some bosses sweeten the deal by matching some of your contributions.
401(k)s were created by Congress...so there are rules. You can contribute up to $19,500 in 2020. And since this money is supposed to be for retirement, withdrawing it too soon means you’ll pay a 10% penalty and income taxes.
403(b): A 401(k) for people who work at a public school, charity, nonprofit, or other tax-exempt orgs. Same contribution limits, tax rules, and penalties apply.
IRA: Stands for Individual Retirement Account. Because HR is staying out of this one. You open your own account at a bank and contribute after-tax dollars — up to $6,000 in 2020.
With a traditional IRA, your contributions may be fully or partially deductible depending on your income and tax status. Meaning you could owe less in taxes now. Then you’ll pay taxes in retirement when you withdraw the money. Withdraw too soon, and you’ll owe the 10% early-withdrawal penalty.
Roth IRA: Another flavor of IRA where you pay taxes upfront and can’t deduct your contributions. This time, the money you withdraw in retirement is tax-free. Limits are the same as a traditional IRA...unless you make the big bucks. Another difference: you can withdraw Roth contributions whenever you want — penalty and tax-free. Key word: contributions. Any investment earnings have to stay put. (Psst...there are Roth versions of 401(k)s, too.)
SEP IRA: As in, Simplified Employee Pension IRA. Better known as an IRA for people who are self-employed or small biz owners. You can open an account for yourself. Or yourself and your employees. 2020 limits are $57,000. Withdraw early, and you pay a penalty. Have more Qs about how this one works? The IRS has answers.
What if I want to invest for something besides retirement?
Meet the “regular taxable brokerage account.” Lots of syllables, very few rules. It’s a catch-all account for money you’ll need before retirement — for a home down payment, to start a new biz, pay for a future wedding, you name it.
There are no contribution limits or penalties for withdrawing your money at any time. Or tax benefits. Uncle Sam wants a cut of your profits, and charges “capital gains tax” on any money you make from selling investments.
And if I need some help covering education expenses?
That’s what 529s are for. You can use these accounts to invest for anyone: yourself, your kids, a neighbor, whatever. Most states offer tax deductions or credits for contributions, and you generally won’t owe taxes on withdrawals — so long as the money’s used for qualified expenses, like tuition, books, and room and board.
Got it. Anything else?
One more big one: HSAs, aka health savings accounts. These are investment accounts where you contribute pre-tax money from your paycheck for future healthcare costs. Think: doc appointments, prescriptions, flu shots, acupuncture, etc. For 2020, single people under 55 can contribute up to $3,550. Families can invest up to $7,100.
HSAs aren’t for everyone. To qualify, you have to be enrolled in a high-deductible insurance plan. Oh, and if you use your HSA funds for happy hour instead of healthcare, you’ll pay a 20% penalty and taxes. On the bright side, unused funds roll over each year.
Part of being smart about your money is putting it in the right place. Let your goals be your guide, and choose an investment account with the benefits that can help you reach them.