Types of Accounts
Checking Accounts
Basic Checking Accounts
This is your bread and butter normal day to day account. If you’re lucky you may get some perks and rewards. If you’re unlucky you may even be charged a small monthly fee for them, or they may have a minimum requirement for deposits or balance. Use them for daily transactions, paying bills, and withdrawing cash. They typically pay you little (or no) interest on your cash.
Interest-Bearing Checking Accounts
These offer the convenience of a checking account with the benefit of earning interest. The rates are usually lower than savings accounts, and there might be more requirements to earn the interest.
Savings Accounts
Traditional Savings Accounts
A traditional savings account is a relatively low risk place to store your money while earning some interest. FDIC insured banks (which most should be) guarantee your money up to a value of $250,000, even if the bank fails. These savings accounts are offered by banks and credit unions and are a good place for building an emergency fund, or saving for a short term goal such as a vacation or house deposit. The interest rates are usually modest, but there's easy access to your funds. For savings you can put away for longer term, you’ll get better returns elsewhere.
High-Yield Savings Accounts
High-yield savings accounts are similar to traditional savings account but will offer you a higher interest rate in exchange for either minimum required balances, or limited access to your money (eg it’s locked up for a year, or longer).
Retirement Savings Accounts
401(k) Plans
This is your typical employer-sponsored retirement plan. Most mid to large employers will offer them, and help you out with contributions to it also.
Contributions: Made with pre-tax dollars, reducing your taxable income in the contribution year. Your employer will often contribute for you also- if they’re offering to match what you put in, this is usually a good idea to take advantage of.
Contribution Limits (2023): You can put in up to $20,500 (additional $6,500 if age 50 or older).
Withdrawal Age: Penalty-free withdrawals start at age 59½, with required minimum distributions (RMDs) starting at age 72. If you want to take the money out sooner, you’ll pay penalties.
Taxes on Withdrawals: Taxed as ordinary income at the time of withdrawal.
Employer Match: Many employers offer a match on your contributions, which can significantly boost your savings.
Investment Options: This is arguably the biggest problem with 401(k) plans- your investment options are limited to the options provided by the plan, which typically include a range of mutual funds. These funds may be expensive as well as not very good. Sadly you don’t have much choice.
Roth Option: Some plans offer a Roth 401(k), where contributions are made with after-tax dollars, and withdrawals are tax-free in retirement.
Traditional IRAs
This is a standard Individual Retirement Account available to anyone with earned income. You get tax relief on your earned income now when you contribute, but the IRS will tax your future withdrawals as income when you take the money out.
Contributions: Made with pre-tax dollars; tax-deductible depending on income, filing status, and coverage by an employer-sponsored plan.
Contribution Limits (2023): Up to $6,000 (additional $1,000 if age 50 or older).
Taxes on Withdrawals: Taxed as ordinary income at withdrawal.
Withdrawal Age: Penalty-free withdrawals start at age 59½; RMDs begin at age 72.
Investment Options: Broad range of options including stocks, bonds, ETFs, and mutual funds.
Eligibility: Available to anyone with earned income, but deductibility is phased out at higher income levels if you or your spouse are covered by a retirement plan at work.
Roth IRAs
Individual retirement account, but the difference here vs traditional IRA is that you get to withdraw income free of tax in the future. The trade off is that you don’t get any tax relief on contributions today.
Contributions: Made with after-tax dollars; not tax-deductible.
Contribution Limits (2023): Up to $6,000 (additional $1,000 if age 50 or older), but phased out at higher income levels.
Taxes on Withdrawals: Withdrawals of contributions are always tax-free. Earnings can be withdrawn tax-free after age 59½ and once the account has been open for 5 years.
Withdrawal Age: Contributions can be withdrawn at any time without penalty. Earnings withdrawal rules are as above.
Investment Options: Similar broad range as Traditional IRAs.
Eligibility: Available to anyone with earned income within the income limits.
Roth Conversions
If you think your income or tax rate in retirement may be higher than it is today, you may want to consider a Roth conversion. This is where you convert a traditional IRA to a Roth IRA. To do this, the size of the conversion in total will be included within your taxable income for this year- so make these decisions carefully. It can often be a good time to do these conversions after significant market declines- your stock values might be down so you pay less income tax, but can still convert all of those positions into a Roth IRA ensuring you won’t face income tax on your withdrawals in the future.
Key Differences
Tax Treatment: 401(k)s and Traditional IRAs offer tax-deferred growth with pre-tax contributions, while Roth IRAs offer tax-free growth and withdrawals with after-tax contributions.
Contribution Limits: 401(k) plans have higher contribution limits compared to IRAs.
Employer Match: Only available in 401(k) plans.
Investment Options: 401(k) plans are limited by employer offerings, while IRAs offer a wider range of investment choices.
Income Restrictions: Roth IRAs have income limits for eligibility; Traditional IRA deductibility is affected by income if you're covered by an employer plan.
Investment Accounts
Brokerage Accounts
A standard brokerage account allows you to invest in stocks, bonds, mutual funds, and more. They offer the potential for higher returns compared to savings accounts but come with more risk. Taxes on gains are due when you sell investments. They can be in your own name, joint names, trust name, LLC etc.
Education Savings Accounts (529 Plans)
These accounts are designed for saving for future education expenses. Contributions grow tax-free, and withdrawals are tax-exempt when used for qualified education expenses.
Specialty Accounts
Health Savings Accounts (HSAs)
HSAs are available to those with high-deductible health plans. They offer triple tax advantages: tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses.
Certificates of Deposit (CDs)
CDs are time-bound deposits offering fixed interest rates, usually higher than savings accounts. They come in various terms, and withdrawing money before maturity can incur penalties.