Know Your Account Types
There are two broad categories of plan types: qualified and non-qualified. Within these groups are a number of important accounts that can help you achieve your financial goals. Let’s take a quick look at each one.
Traditional Individual Retirement Account (“IRA”)
IRA accounts are often the core account for retirement savings. Contributions are typically tax-deductible (i.e., made with pre-tax assets), which lowers your taxable income. Also, you are not taxed on investment growth until you make a withdrawal, hopefully in retirement, at which time you will be at a lower marginal tax rate.
401(k)s are typically offered through your employer. While there are important differences and similarities between IRAs and 401(k) accounts, the big benefit of a 401(k) is that your employer can also make contributions, helping you build up your retirement savings quicker.
Contributions into a Roth IRA are made with after-tax assets, so they are not tax-deductible like a Traditional IRA. Withdrawals, however, are tax-free after five years (and other important age conditions are met), which can have a dramatically positive impact on your long-term financial health. As of 2017, you can contribute up to an annual maximum of $5,500 if you are age 49 and under and $6,500 if you are age 50 and above.
529 Savings Plan
If you are saving for post-secondary education, you will want to use a 529 Savings Plan. 529 plans are sponsored by states, not the federal government. You don’t have to live in the state that sponsors the plan you choose, nor does your child have to go to school in that state. What set 529 plans apart from others is that your contributions grow tax-free if they are used for college.
Cash Account (for Investments)
The most important non-qualified account type to know about is that cash account. Unlike registered plans, a cash account does not have tax advantages, but there are also fewer restrictions. The big benefit to cash accounts is that you can use margin (leverage) to increase your exposure to markets and potentially increase your returns. This is a sophisticated strategy that can also lead to outsized losses as well, so it’s not for everyone.
A general rule of thumb is to maximize, if appropriate to your situation, your qualified plans in order to take advantage of the tax benefits, before making significant investments into a cash account.
Do you think you can benefit from one of these account types? Contact me for a consultation!