Terminology to Understand
Before we jump head first into reviewing some of the best investing accounts, you should be familiar with some terminology that we will use to describe each account type.
1. Eligibility - Who can open the account type. Certain types of investing accounts impose requirements that you must meet in order to be able to use the account. Sometimes this relates to your income, your age, or a workplace sponsored retirement plan.
2. Contribution limit - How much you are allowed to contribute to the account. Some of the accounts below limit the amount of money that you can put into the account. Accounts that limit contributions often come with tax benefits so the IRS puts a cap on how much you can put into these accounts.
3. Withdrawal rules - The rules you must follow to pull money out of a certain investment account. These rules often state that you can't withdraw money from the account unless you reach a certain age or have had the account open for a certain amount of time.
4. Required minimum distributions - For certain account types, the government requires you to pull money out of the account once you are a certain age. The accounts that have required minimum distributions (RMDs) are often accounts in which you defer paying taxes on.
Cash Accounts
Cash accounts are not exactly investment accounts as cash is not truly an investment. However, some cash accounts can serve as an important part of your financial plan and can work in tandem with other investing accounts - which is why these accounts are worth noting.
1. High yield savings account
Eligibility: As long as you are at least 18 years of age, you can open a high yield savings account in most states.
Contribution limit: Unlimited - you can contribute as much to the account as you want.
Withdrawal rules: You can withdraw money from a high yield savings account whenever you want, but you typically can't withdraw money from the account more than 6 times per month.
Required minimum distributions: There are no required minimum distributions for a high yield savings account.
A high yield savings account is a type of savings account that earns a higher APY when compared to a traditional savings account. In fact, high yield savings account can earn an average of 4% APY, which is 10 times higher than the equivalent traditional savings account.
Keep in mind that you can't hold any investments within a high yield savings account - just cash. So technically a high yield savings account is a bank account and not an investment account. However, a high yield savings account can be used in tandem with other investing accounts. We will look at this later on.
Brokerage Accounts
Eligibility: As long as you are at least 18 years of age, you can open a brokerage account in most states.
Contribution limit: Unlimited - you can contribute as much to the account as you want.
Withdrawal rules: You can withdraw money from a brokerage account whenever you want, but you will have to pay either short or long term capital gains tax depending upon how long you held investments within the account before selling them.
Required minimum distributions: There are no required minimum distributions for a brokerage account.
A standard
brokerage account is the most common investing account available. The account simply allows you to buy and sell almost any investment that you want. These accounts are often called taxable brokerage accounts as the gains within your account are subject to
capital gains tax which can be 0%, 15% or 20% depending upon your taxable income and filing status. In order to get the most favorable tax rate, you need to hold your investments in the account for over a year.
The primary advantage of a brokerage account is the flexibility. Unlike a retirement account, there are no income limitations to qualify for these accounts, and no contribution limits. Anyone who is 18 years old and has a social security number can open one of these accounts. You can own a brokerage account as an individual, or jointly with another person.
Retirement Accounts
Investing for retirement is arguably the most common investing goal, and there are accounts designed specifically for this purpose. 401(k)s, 403b and 457 plans are employer sponsored retirement plans that can help you build wealth with the help of an employer match. IRAs, or individual retirement accounts, are retirement accounts you can hold outside of work in addition to a 401k.
1. Traditional 401k
Eligibility: The requirements you must meet to contribute to a 401k can vary by employer. Some employers require you to be a certain age and work at the company for at least a year to use the account. Check with your company's HR department to see if you are eligible.
Contribution limit: You can contribute $22,500 per year, or $30,000 per year if you are 50 or older.
Withdrawal rules: You can withdraw money from the account once you are 59 and a half years old. If you try to withdraw before then, you will incur a 10% penalty and income taxes on the amount you withdrew.
Required minimum distributions: You must start taking the required minimum distribution from a traditional 401k once you are 73 years old. The amount you must withdraw is calculated by dividing your account balance by your remaining life expectancy.
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401k is an employer sponsored retirement plan and works like this. You contribute to the account with pre-tax dollars into a selection of investments offered by your plan, and your money grows tax deferred until retirement. "Tax deferred" simply means that you are going to pay taxes on the money you contribute to the account later when you take the money out in retirement and not today.
Every month, your employer will take an amount out of your paycheck and put it into your 401k before you have to pay taxes on that amount. The amount that you contribute to a traditional 401k can also lower your taxable income for the year.
For example, lets say that you make $80,000 per year and decide to contribute 10% of your income ($8,000) to a traditional 401k. You can deduct the contributions of $8,000 on your taxes. This means your taxable income would now be $72,000 for the year.
Most 401k plans offer a small selection of mutual funds and target date retirement funds that you can invest in. Remember a 401k simply holds your investments. When you enroll in your company 401k plan, you need to select the investments that you want to hold within the account.
Finally, many employers offer a match up to a set percentage of your total compensation. For example, lets say that you make $80,000 per year and your employer offers a 3% match to your 401k. If you contribute 3% of your salary to your 401k ($2,400), your employer will match that contribution with another 3% of your salary.
2. Roth 401k
Eligibility: The requirements you must meet to contribute to a Roth 401k can vary by employer. Some employers require you to be a certain age and work at the company for at least a year to use the account. Check with your company's HR department to see if you are eligible.
Contribution limit: You can contribute $22,500 per year, or $30,000 per year if you are 50 or older.
Withdrawal rules: You can withdraw money from the account if it has been opened for at least 5 years and you are 59 and a half years old. If you try to withdraw before then, you will incur a 10% penalty and income taxes on the amount you withdrew.
Required minimum distributions: Starting in 2024, you will no longer have to take RMDs from a Roth 401k thanks to the passing of the
Secure Act 2.0.
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Roth 401k is an employer sponsored retirement plan that works in the opposite way of a traditional 401k. With a Roth 401k, you contribute to the account with dollars that you have already paid tax on, but then you don't have to pay taxes when you pull the money out in retirement.
Similar to a traditional 401k, you can invest the money you place in a Roth 401k into a small selection of mutual funds and target date retirement funds. Unlike a traditional 401k, the contributions you make to a Roth 401k are not tax deductible.
So, you pay taxes on the dollars you contribute to a Roth 401k today, but then enjoy tax free withdrawals in retirement. Most employers will also offer a match on the contributions that you make to a Roth 401k up to a certain percentage of your compensation.
3. Solo 401k
Eligibility: If you are self employed or a business owner with no employees, you are eligible to open a Solo 401k. You can choose to open either a Traditional or Roth Solo 401k.
Contribution limit: You can contribute a total of $66,000 per year, or $73,500 per year. Since you are both a business owner and and employee of your business, you can contribute the same amount you would under a regular 401k as an employee and the remaining amount from the business.
Withdrawal rules: The same withdrawal rules that apply to a regular employer sponsored 401k also apply to a Solo 401k - both the Traditional and Roth.
Required minimum distributions: You must start taking the required minimum distribution from a Solo 401k once you are 73 years old. The amount you must withdraw is calculated by dividing your account balance by your remaining life expectancy.
A Solo 401k is a retirement account specifically designed to help business owners with no employees save for retirement. You can opt for either a Traditional or Roth Solo 401k. Both of these accounts function the same as an employer sponsored Traditional or Roth 401k.
If you opt for a Traditional Solo 401k, you get a tax break today and then pay taxes when you pull the money out of the account in retirement. If you open for a Roth Solo 401k, you pay taxes on the dollars you contribute today, but then enjoy tax free withdrawals in retirement.
The contributions you can make to a Solo 401k are much higher when compared to a standard 401k. The reason is that you can make contributions as both the employee of your business, as well as the business owner.
As the employee you can contribute $22,500 per year or $30,000 if you are 50 or older. You can contribute 100% of your compensation if it is below those levels. The business itself can contribute up to 25% of its net profit up to the limit of $66,000 per year.
4. 403b and 457 Plans
Eligibility: You can use a 403b Plan if you are a public school employee, or work for a tax exempt organization. Teachers, nurses, professors, doctors, and librarians can potentially use a 403b Plan. You can use a 457 Plan if you are a state or local government employee.
Contribution limit: You can contribute $22,500 per year, or $30,000 per year if you are 50 or older.
Withdrawal rules: You can withdraw money from a 403b Plan once you are 59 and a half years old. If you try to withdraw before then, you will incur a 10% penalty and income taxes on the amount you withdrew.
You can withdraw money from a 457 Plan once you leave your employer or retire. You won't owe a penalty if you withdraw money before you are 59 and a half, but you will owe income taxes on the amount that you withdraw.
Required minimum distributions: You must start taking the required minimum distribution from a traditional 403b and 457 Plan once you are 73 years old. The amount you must withdraw is calculated by dividing your account balance by your remaining life expectancy.
If you opt to go for the Roth version of the 403b or 457 Plan, you will not be required to take any RMDs starting in 2024 thanks to the passing of the Secure Act 2.0.
A 403b plan is a retirement account for employees who work for non-profit, or tax exempt businesses. The plan mirrors the 401k that is offered for employees who work at for-profit businesses. With this in mind, you can opt for a Traditional 403b Plan for tax deferred benefits, or a Roth 403b Plan for tax free benefits.
A 457 plan is a retirement plan for state and local government employees. The 457 Plan offers both a Traditional and Roth option depending if you want tax deferred or tax free benefits. Keep in mind that a 457 Plan typically does not offer a match, where as a 403b plan can.
5. Traditional IRA
Eligibility: In general, anyone with earned income can open a Traditional IRA.
Contribution limit: You can contribute $6,500 per year or $7,500 per year if you are 50 or older.
Withdrawal rules: You can withdraw money from the account once you are 59 and a half years old. If you try to withdraw money before then, you can incur a 10% penalty and additional income taxes.
Required minimum distributions: You must start taking the required minimum distribution from a traditional IRA once you are 73 years old. The amount you must withdraw is calculated by dividing your account balance by your remaining life expectancy.
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Traditional IRA is a retirement account that allows you to make contributions with income that can grow tax deferred. By deferring your tax, you won't pay taxes until you make a withdraw. Think of a traditional IRA as a 401k plan that is held outside of work.
The contributions you make to a traditional IRA can also potentially be tax deductible depending upon a variety of factors including income, tax filing status, and whether you use an employer sponsored retirement plan, such as a 401k. You can hold most investments within a traditional IRA such as stocks, bonds, investment funds and others.
6. Roth IRA
Eligibility: In order to be eligible for a Roth IRA, your modified adjusted gross income (MAGI) has to be below certain levels that can vary depending upon your tax filing status.
If your tax filing status is single, head of household, or married filing seperately, your modified adjusted gross income (MAGI) has to be $138,000 per year or less to make the maximum contribution to a Roth IRA. If your income is between $138,000 and $153,000 you can contribute a reduced amount to a Roth IRA. However if your income is above $153,000, you can't use a Roth IRA at all.
If your tax filing status is married filing jointly or qualified widow(er), your modified adjusted gross income (MAGI) has to be $218,000 per year or less to make the maximum contribution to a Roth IRA. If your income is between $218,000 and $228,000 you can contribute a reduced amount to a Roth IRA. However if your income is above $228,000, you can't use a Roth IRA at all.
If your income is too high to use a standard Roth IRA, you can get around the problem by using a
Backdoor Roth IRA.
Contribution limit: You can contribute $6,500 per year or $7,500 per year if you are 50 or older.
Withdrawal rules: You can withdraw money from the account if it has been opened for at least 5 years and you are 59 and a half years old. If you try to withdraw before then, you will incur a 10% penalty and income taxes on the amount you withdrew.
The exception to this is that you can withdraw your base contributions. So, if you contributed $6,500 to a Roth IRA, you can withdraw this amount without incurring a penalty. However, you can't withdraw any money you have earned from the investments within the account.
Required minimum distributions: There are no required minimum distributions for a Roth IRA.
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Roth IRA is a retirement account that is held outside of work. The Roth IRA works in the opposite way of a traditional IRA. You contribure to a Roth IRA with dollars that you have already paid taxes on. Your money then grows tax free and you don't have to pay taxes when you pull money out of the account in retirement.
Additionally, a Roth IRA does not have RMDs. This means you can wait to withdraw from the account for as long or short as you like. Similar to a traditional IRA, you can old most investments within a Roth IRA including stocks, bonds, mutual funds, and more.
Education Accounts
If your goal is to save and invest specifically for educational expenses, there are a couple accounts that are set up to do just that. These accounts typically come with tax advantages and can be used for any educational related expense.
1. College 529 Plan
Eligibility: Almost anyone can open and fund a College 529 Plan for a student. It can be parents, grandparents, relatives, friends, or the student themselves.
Contribution limit: The amount you can contribute will vary by state. The total amount you can contribute to the account can range from $235,000 to $550,000. The IRS view contributions to a College 529 Plan as gifts and not contributions.
Due to this, an individual can contribute $17,000 per year and a married couple can contribute $34,000 per year without incurring a "gift tax." However, the total amount that an individual can contribute over a 5 year period is $85,000 or $170,000 as a married couple.
Withdrawal rules: You can withdraw money from the account tax and penalty free at any time as long as the withdrawals are used for qualified educational expenses.
Required minimum distributions: There are no required minimum distributions for a College 529 Plan.
A 529 plan is a savings and investment account designed to help pay for educational expenses. A 529 plan offers tax deferred growth, and withdrawals are tax free as long as they are used for educational expenses. These accounts are administered by the 50 states so the rules can vary state to state. You can opt to purchase a plan directly through your state or through a brokerage.
Almost anyone can open a 529 plan, but most often it is parents and grandparents setting up the account for their children or grandchildren. 529 plans can be broken down into two types. First, is the education savings plan in which the account holder contributes money which is invested in a pre-set selection of investments. Second, is the prepaid tuition plans in which you lock in tuition expenses at current rates for students who won't attend college until years in the future.
2. Coverdell ESA
Eligibility: You have a modified adjusted gross income (MAGI) under $95,000 per year as an invidual or $190,000 as a married couple, you can open a Coverdell ESA. You can contribute a reduced amount if your income is higher than that, but you will not qualify for a Coverdell ESA at all if your income is above $110,000 as an individual or $220,000 as a married couple.
Contribution limit: You can contribute up to $2,000 per year. The benefiary must be under 18 years old during the time of contributions.
Withdrawal rules: You can withdraw money from the account tax and penalty free at any time as long as the withdrawals are used for qualified educational expenses.
Required minimum distributions: You must withdraw any remaining assets within a Coverdell ESA within 30 days of when the beneficiary turns 30 years old.
A Coverdell education savings account (ESA) is similar to a 529 plan, but has several differences. A Coverdell ESA is a trust or custodial account used to save for educational expenses. Similar to a 529 plan, a Coverdell ESA offers tax deferred growth, and withdrawals are tax free as long as they are used for educational expenses. This account can be set up at most brokerages or financial advisors.
The Coverdell ESA does have a couple of different rules that 529 plans are not subject to. Most notably would be eligibility requirements, and contribution limits. Additionally, a Coverdell ESA typically offers more investment options than a College 529 Plan.
Custodial Accounts
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custodial account is a type of investing account set up by an adult for a minor. Once an account is established, the custodian can contribute to the account and decide what assets are to be bought with the contributions. Once the minor reaches legal age (typically 21 in most states), the minor obtains full control of the account and can use the funds as they please. There are two main custodial accounts.
1. UGMA account
Eligibility: Almost anyone can open and fund a UGMA account for a minor. It can be parents, grandparents, relatives, and even friends.
Contribution limit: You can contribute as much as you like to the account, but contributions above $17,000 or $34,000 for married couples per year will incur a federal gift tax.
Withdrawal rules: You can withdraw money from the account at any time as long as the money is used in the best interest of the beneficiary.
Required minimum distributions: There are no required minimum distributions for a UGMA account.
The UGMA account is the Uniform Gift to Minors Act. Deposits made into this account are irrevocable. This means that once a deposit is made into the account, the minor owns that deposit and it cannot be reversed. UGMA accounts are limited to holding financial assets such as cash, stock, bonds and annuities. UGMA accounts are available in all 50 states.
2. UTMA account
Eligibility: Almost anyone can open and fund a UTMA account for a minor. It can be parents, grandparents, relatives, and even friends.
Contribution limit: You can contribute as much as you like to the account, but contributions above $17,000 or $34,000 for married couples per year will incur a federal gift tax.
Withdrawal rules: You can withdraw money from the account at any time as long as the money is used in the best interest of the beneficiary.
Required minimum distributions: There are no required minimum distributions for a UTMA account.
The UTMA account is the Uniform Transfer to Minors Act. A UTMA account functions fairly similar to a UGMA account as deposits are also irrevocable. However, there is one key difference. Unlike a UGMA account, a UTMA account can contain any type of tangible or intangible asset including real estate, fine art, and intellectual property. UTMA accounts are not available in all states.
Which account type should you open?
The short answer is that it depends on your individual situation. However, it might be best to use the accounts in tandem with one another and not view them seperately. With that being said, it can be efficient to use the account types in the following order.
1. Set up an emergency fund in a high yield savings accountThe first investing account that you could set up is not an investing account, but instead a bank account. Investing is awesome, but before you dive head first into setting up your investing accounts and buying investments, it is a good idea to set up an emergency fund.
An emergency fund is a liquid cash reserve to help cover any unexpected emergencies that arise in life such as the loss of a job, the breakdown of a car, and unforeseen medical bills. A great place to build an emergency fund would be through a high yield savings account.
A high yield savings account pays a higher than average APY when compared to a traditional savings account and will allow you to quickly access the money if an emergency comes up. If all of your money is tied up in investments, you may have to tap into them to cover an unexpected emergency which can slow down your progress towards building wealth and trigger additional taxes.
Learn how to set up an emergency fund2. Invest through a 401k, 403b or 457 Plan (preferably a Roth option if available)Once you have an emergency fund set up through a high yield savings account to prevent you from going backwards, you could use a 401k, 403b or 457 plan (depending on what you are eligible for) to start saving for your future self.
If your company offers one of these accounts, it is a good idea to take advantage of it - especially if your employer offers a match. We would recommend opting for a Roth version of one of these accounts if one is available.
Although it can be tempting to get a tax break today through a traditional 401k account, you will be happy when you don't have to pay any taxes in retirement when you go with the Roth version of the account. The classic advice is that you should use a traditional 401k if you think taxes will be lower in the future and a Roth 401k if you think taxes will be higher in the future.
So, ask yourself a simple questions. Is it more likely the government increases taxes, or decreases taxes? On a final note, we recommend only investing enough in your 401k plan to get your employer's full match. Some 401k plans limit your investment options which is why you may want to open a Roth IRA in addition to a 401k.
3. Invest through an IRA (preferably a Roth)Once you have contributed enough to your 401k plan to get your full employers match, it can be beneficial to start diverting dollars towards an IRA. There are a couple of reasons for this. First, IRAs typically allow you to have access to a broader selection of investments that might not be available in your 401k plan.
Secondly, an IRA is an investing account that you hold outside of work. Although a 401k is great, there is no guarantee that every company you ever work for will offer one. We would again recommend a Roth IRA for the same reasons we discussed above. Ideally, you want to make the maximum contribution allowed to a Roth IRA.
4. Save for your kids through an Education or Custodian AccountIf you have additional money left over after the first three steps, you can set up an education or custodian account to help your kids. If you specifially want to help save for your kids college, you can use a College 529 Plan or Coverdell ESA. We would recommend a College 529 plan due to the higher contribution limits and no income eligibility requirements.
If you want to help your kids get a jump start on building wealth, you can use a UGMA or UTMA account. Either one of these accounts is good, but you can decide which one you want to open based upon what assets you want to put in the account.
5. Jump back to your 401k if you still have money to investYou can always jump back to your company's 401k plan if you want to keep investing after going through the first four steps. You might not get an employer match on your contributions, but you can invest a lot more money in a 401k than through an IRA due to the higher contribution limits.
6. Invest through a brokerage account for additional investingFinally, you can invest through a brokerage account if you want to make additional investments. A brokerage account will not give you any of the tax benefits of the other accounts, but you can invest as much as you want in the account and get access to the investments within the account whenever you like.
What investments should you put in these accounts?
The short answer is that it depends. Your age, investing time horizon, and
risk tolerance can all be a factor in what investments you should put in the accounts we discussed above. With that being said, it can be a good idea to start with investment funds.
An investment fund pools the money of lots of different investors to buy a range of assets including stocks and bonds. It is a good way to buy lots of stocks all at once, which lowers your exposure to risk thanks to
diversification.
If you are using a 401k, there is a good chance that your plan offers a selection of mutual funds or target date retirement funds for you to invest in - both of which are investment funds. You can also put a mix of investment funds within an IRA or brokerage account.
The two most common types of investment funds are
mutual funds and index funds. A mutual fund is actively managed by a professional fund manager whose goal is to beat the average return of the stock market. An index fund is not actively managed and instead aims to provide similar returns to the stock market index that it is tracking.
Potential mutual funds to hold in your accountsThe T. Rowe Price US Equity Research Fund (PRCOX). The Massachusetts Investors Growth Stock Fund (MIGFX). The BlackRock Exchange Blackrock Fund (STSEX). The State Street US Core Equity Fund (SSAQX).
Important note: Keep in mind that these mutual funds are only examples of what you could invest in and should not be taken as strict financial advice. The mutual funds that are right for you could be different. We recommend speaking with a licensed
financial advisor if you need help choosing mutual funds.
Potential index funds to hold in your accountsThe Fidelity 500 Index Fund (FXAIX). The Fidelity Zero Large Cap Index Fund (FNILX). The Schwad S&P 500 Index Fund (SWPPX). The Vangaurd S&P 500 ETF (VOO). The SPDR S&P 500 ETF Trust (SPY).
Important note: Keep in mind that these index funds are only examples of what you could invest in and should not be taken as strict financial advice. The index funds that are right for you could be different. We recommend speaking with a licensed
financial advisor if you need help choosing index funds.
How and where to open these accounts
If you are looking to open a 401k, 403b or 457 Plan, you will need to speak to your employer to open one of these accounts. An IRA, education or custodial account can typically be opened through an
online broker or
robo advisor by filling out at application.
In general, expect to have to provide the following when opening one of these accounts online - your name, address, contact information, date of birth, ID, employment status, and annual income. Once your application is approved, you can deposit money from your bank account and use that money to buy your investments to hold in your account.
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