Understanding Different Types of Investment Accounts

Investing is a key component of building wealth and securing financial stability. There are various types of investment accounts available, each serving different purposes and offering unique benefits, including but not limited to:

• Individual brokerage accounts
• Retirement accounts
  • Traditional IRAs
  • Roth IRAs
  • 401(k)s
  • SEP IRAs 
  • Simple IRAs
• Custodial accounts
  • UGMAs & UTMAs
• 529 plans

Understanding these accounts, and knowing their advantages and disadvantages, can help you make informed decisions about where to place your money to best set you up to meet your financial goals.

This article will explore the different types of investment accounts and compare them to traditional savings accounts to highlight their distinct advantages.

Investment accounts vs. savings accounts

Investment accounts and savings accounts are both essential tools for managing money, but they serve different purposes. Savings accounts are typically used for short-term goals and emergency funds, offering low-risk and easy access to your money with modest interest rates.

Investment accounts, on the other hand, are designed for long-term wealth growth. They allow you to invest in assets like stocks, bonds, and mutual funds. A high-yield investment account, for instance, can earn greater returns over time, but can also come with increased risk when compared to a traditional savings account.

Savings accounts are ideal for preserving capital and maintaining liquidity, whereas investment accounts can be better suited for helping to achieve long-term financial goals such as retirement, education funding, or significant wealth accumulation.

Individual brokerage accounts

An individual brokerage account (sometimes called a personal investment account) is a type of investment account that allows you to buy and sell various securities, such as stocks, bonds, ETFs, and mutual funds. These accounts are flexible and accessible to anyone who wishes to invest in the stock market.

Managed investment accounts are individual brokerage accounts that are run by a third party, and are best for investors with limited knowledge or time needed to understand market nuances and rules.

What are the pros and cons of individual brokerage accounts?

Pros	Cons
Flexibility: You can invest in a wide range of assets without restrictions on contribution limits or withdrawal rules. Liquidity: Assets in a brokerage account can be easily bought or sold, providing quick access to funds if needed. No Income Limits: Unlike some retirement accounts, there are no income limits for opening or contributing to a brokerage account.	Taxable Events: Profits from the sale of securities are subject to capital gains taxes. Dividends and interest earned are also taxable. Risk: Investments in the stock market can be volatile, and there’s a risk of losing your principal investment. Fees: Brokerage accounts may incur transaction fees, account maintenance fees, and other charges that can eat into your returns.

Retirement accounts

Retirement accounts are designed to help individuals save for their retirement years with tax advantages. There are several types of safe investments for retirement, including a number of IRA investment account options, each with its own rules and benefits.

Types of retirement accounts

1. Traditional IRA: Contributions may be tax-deductible, and earnings grow tax-deferred until withdrawals are made during retirement. Withdrawals are taxed as ordinary income.
2. Roth IRA: Contributions are made with after-tax dollars, but earnings and qualified withdrawals are tax-free. There are income limits for contributing to a Roth IRA.
3. 401(k): Offered by employers, 401(k) plans allow employees to contribute pre-tax income, which grows tax-deferred. Employers often match contributions, providing additional benefits.
4. SEP IRA: Simplified Employee Pension IRAs are designed for self-employed individuals and small business owners. Contributions are tax-deductible, and the account offers high contribution limits.
5. SIMPLE IRA: Savings Incentive Match Plan for Employees IRAs are available to small businesses and self-employed individuals. They feature lower contribution limits than SEP IRAs but are easier to set up and maintain.

Comparing types of retirement accounts

When choosing between different retirement accounts, consider factors such as tax treatment, contribution limits, and eligibility requirements. While Traditional IRAs and 401(k)s offer tax-deferred growth — which can be beneficial if you expect to be in a lower tax bracket during retirement — Roth IRAs provide tax-free withdrawals, making them attractive if you anticipate being in a higher tax bracket in the future.

If you’re wondering “What IRA is right for me?”, the table below may provide some answers.

	Traditional IRA	Roth IRA	401(k)	SEP IRA	SIMPLE IRA
Tax Treatment	Contributions may be tax-deductible; earnings grow tax-deferred; withdrawals taxed as ordinary income	Contributions made with after-tax dollars; earnings and qualified withdrawals are tax-free	Contributions are pre-tax; earnings grow tax-deferred; withdrawals taxed as ordinary income	Contributions are tax-deductible; earnings grow tax-deferred; withdrawals taxed as ordinary income	Contributions are pre-tax; earnings grow tax-deferred; withdrawals taxed as ordinary income
Contribution Limits	$6,500 annually ($7,500 if 50 or older) in 2024	$6,500 annually ($7,500 if 50 or older) in 2024	$22,500 annually ($30,000 if 50 or older) in 2024	The lesser of 25% of compensation or $66,000 in 2024	$15,500 annually ($19,000 if 50 or older) in 2024
Income Limits	No income limits for contributions; tax deductions may be limited if covered by an employer plan	Single: $153,000; Married: $228,000 (modified AGI) in 2024	None	None	None
Employer Contribution	N/A	N/A	Often includes employer-matching contributions	Employer-funded; no employee contributions	Employer matching contributions required
Required Minimum Distributions (RMDs)	Must start at age 73	None	Must start at age 73	Must start at age 73	Must start at age 73
Early Withdrawal Penalties	10% penalty on withdrawals before age 59½, with some exceptions	Contributions can be withdrawn tax- and penalty-free anytime; earnings subject to a 10% penalty before age 59½, with some exceptions	10% penalty on withdrawals before age 59½, with some exceptions	10% penalty on withdrawals before age 59½, with some exceptions	10% penalty on withdrawals before age 59½, with some exceptions

Custodial accounts

Custodial accounts are investment accounts set up by an adult on behalf of a minor. These accounts are governed by the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA), depending on what your state offers. 

What are the pros and cons of custodial accounts?

Pros

Cons

Education and Experience: Custodial accounts can be used to teach minors about investing and financial responsibility. Flexibility: Funds can be used for various expenses, including education, with fewer restrictions than education-specific accounts. Gift Tax Benefits: Contributions to custodial accounts can help reduce the donor’s taxable estate.

Irrevocable: Once funds are placed in a custodial account investment, they cannot be taken back by the donor and must be used for the benefit of the minor. Tax Implications: Earnings over a certain threshold are subject to the “kiddie tax,” which taxes the income at the parent’s tax rate. Loss of Control: When the minor reaches the age of majority (18 or 21, depending on the state), they gain full control of the account, which might not align with the original intent of the donor.

Education savings accounts

Education savings accounts are designed to help families save for future education expenses. The most common type of education savings account is the 529 plan.

What are the pros and cons of 529 plans?

529 plans offer significant advantages for those looking to save for education expenses. One of the main benefits is the tax advantages they provide. Contributions to a 529 plan grow tax-deferred, and withdrawals used for qualified education expenses are tax-free, making these plans an attractive option for long-term education savings.

Additionally, 529 plans typically have high contribution limits, allowing families to save substantial amounts over time. Some states also offer tax deductions or credits for contributions to their 529 plans, providing further incentives to invest in these accounts.

Another benefit is the flexibility in usage, as funds can be used for a wide range of education-related expenses, including tuition, fees, books, and room and board.

However, 529 plans also have some drawbacks. Withdrawals not used for qualified education expenses are subject to income tax and a 10% penalty on earnings, which can significantly reduce the account’s value if the funds are needed for other purposes.

Additionally, investment options within 529 plans are often limited to a selection of pre-determined portfolios, which may not align with every investor’s preferences or risk tolerance.

Lastly, assets held in a 529 investment account are considered when calculating a student’s financial aid eligibility, potentially reducing the amount of aid they receive.

Continue reading: What are the tax benefits of 529 plans in Texas?

529 plans vs custodial accounts

When comparing 529 plans to custodial accounts for education savings, consider the following:

529 Plans	Custodial Accounts
Tax Benefits: Significant tax advantages for qualified education expenses. Control: The account owner retains control over the education funds for grandchildren or children and can change the beneficiary if needed. Purpose: Funds are specifically intended for education expenses, providing clear guidelines for use.	Flexibility: Can be used for various expenses, not limited to education. Ownership Transfer: Full control of the account is transferred to the minor at the age of majority. Tax Considerations: Potentially higher tax burden due to the kiddie tax on earnings.

Manage your investment accounts with help from Avidian Wealth Solutions

Understanding which is the best investment account for your unique situation and needs can be complex. With all of the various types of investment accounts available, it’s important to clearly define your goals, manage your expectations, and review the advantages and disadvantages that accompany each investment account type.

Whether you’re in need of high-net-worth retirement planning, help with saving for your child’s education, or looking to build a diversified investment portfolio, Avidian’s team of experienced wealth advisors is here to help guide you every step of the way. Contact us today to learn how we can help you put plans in place that work to manage and grow your wealth with confidence.

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