Which investment account is right for you?
CNBC do it posts a new financial task to accomplish each day for a month. These are all simple and urgent activities to distract you from the news for a moment and hopefully put you on a better financial footing. We are on day 26 of 30.
With all the economic uncertainty that reigns right now, it may seem like a scary time to start investing. But there is no “right” time to invest, say financial experts. Dipping your toes now, if you’ve never invested before, can help make investing a habit in good times and in bad times.
“You can’t time the market” is standard financial advice for a reason. No one knows what will happen next, and it’s impossible to say when the market will bottom out and when it will rebound. This is why many financial advisers suggest paying money steadily over time.
Not everyone is able to invest right now, and you shouldn’t be focusing on investing if you don’t have emergency savings. But if you’re in a stable financial position, take the time today to find out which investment account is right for you.
Different types of accounts achieve different types of goals: a 401 (k) is ideal for retirement, while a brokerage account is best for those with financial goals in at least five years, but closer. than retirement, like buying a house or going on a dream vacation.
Here is an overview of four common types of investment accounts.
401 (k)
A 401 (k) is an employer sponsored retirement plan. This is called a “tax-deferred” investment account, which is the money you contribute to it – up to $ 19,500 for individuals in 2020 – reduces your taxable income for the year. This tax break is designed to encourage you to save for your retirement now. You pay taxes on your withdrawals at retirement.
Experts generally recommend contributing at least enough to your 401 (k) to receive the full match from your employer, if they offer one. Typically, an employer will match any contribution you make to your 401 (k) up to a certain amount, say $ 1 for $ 1 up to 6% of your salary.
You can start withdrawing money without penalty at 59½ in most cases. If you withdraw money before this date, you will pay a 10% early withdrawal penalty and income taxes on the distributions.
Remember that all of the accounts listed here are financial accounts that facilitate investing, not the investments themselves. Once you have decided which type you want to open, you will still need to choose what to invest in. This article details exactly how to choose investments for your 401 (k).
One of the main factors of investing, regardless of the type of account, is costs. You want to minimize them as much as possible, especially management fees and investment expense ratios.
Individual retirement account
Like a 401 (k), you pay pre-tax money – up to $ 6,000 in 2020 for those under 50 – and select investments based on what the financial institution offers.
One of the advantages of IRAs is that you will generally have a lot more investment options than in a 401 (k). It can help you diversify properly and keep costs low.
Roth IRA
Roths are a type of IRA, except that instead of paying pre-tax money, you invest income that’s already taxed. Then, when you make withdrawals at retirement, you pay no tax. You lock in your current tax rate when you contribute, which makes Roth IRA a attractive investment account for younger people, who are likely in a lower tax bracket than they will be later.
Another advantage: contributions can be withdrawn at any time, without tax or penalty, since you have already paid taxes on the money you contribute. This can turn a Roth into a secondary emergency fund, if you need it. However, experts strongly advise against withdrawing the funds you will need in retirement.
In some cases, you can also withdraw up to $ 10,000 towards the purchase of a first home. If you are able, investing in both a 401 (k) or an IRA and a Roth IRA is a smart move because it adds diversity to your retirement income streams, which is always a good idea.
That said, unlike traditional IRAs, Roths have income limits: individuals must have a modified adjusted gross income (MAGI) of less than $ 139,000 in 2020 to contribute to one.
Brokerage account
Brokerage accounts are taxable investment accounts to which an investor can contribute and withdraw at their discretion. They are ideal for savings or goals that are five years or more down the line.
You can buy individual company stocks and other types of alternative investments through these accounts, and there is usually a much wider selection of investment options than are available through your retirement investment accounts. You pay taxes when you earn money on an asset in the account, such as selling a stock. But you can still invest in less risky options, like index funds.
Although they are growing in popularity, you should still be careful to start only with a brokerage account. Most people don’t have enough emergency savings or retirement investments, which should be prioritized before contributing to a brokerage account.
When trying to decide where to invest first, Ryan J. Marshall, a certified New Jersey-based financial planner, recommends the following order:
- Contribute to your 401 (k) until the full match
- Get a Roth IRA contribution if you are eligible
- Maximize your corporate retirement plan
- Open a brokerage account for additional investments
While you can use a brokerage account to supplement your savings, remember that these are not the same thing. And as with any investment, there is always the risk that you will lose money, even if historically the market has always gone up.
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