Choosing an investment account is not something to take lightly. One wrong decision can wipe out your savings and cause you major headaches come tax season.
To help you avoid this, let’s take an in-depth look at the most common types of investment accounts in the United States and the scenarios for which they are best suited. Make sure you understand the basics of investing before proceeding; otherwise, much of what we’re going to discuss will be meaningless.
What is an investment account in the United States?
An investment account is a service through which you can buy, hold and sell assets such as stocks, ETFs, bonds and mutual funds. It is connected to your bank account, allowing you to transfer money back and forth when you need it. An investment account also helps you track your financial progress through analysis tools and statements.
Several major banks (including Wells Fargo) offer investment accounts. There are also independent services such as Robinhood and Interactive Brokers through which you can get started.
Regardless of the financial institution you choose, their products will conform to government programs tailored to different financial objectives. Each program comes with its own rules regarding taxes, deposits, withdrawals, types of assets you can buy and other important factors. It is these programs that make up the different “types of investment accounts” that we will explore in this guide.
How do you open an investment account?
To open an investment account, you simply choose the brokerage you’d like to work with and visit their website to fill out an application.
From there, you will typically complete the following steps:
Submit your tax identification number.
Complete the brokerage’s onboarding process (analyze your risk tolerance, etc.).
Deposit funds into your new account.
Research the various assets you can purchase before making your first investment.
The process may be a little different if it is a company-sponsored plan. Your HR representative will likely work with you and handle much of the paperwork necessary to set up your account.
Types of investment accounts in the United States
Retirement Accounts
There are many, many retirement accounts to choose from. However, don’t let that scare you; as you’ll see, most of these accounts come with strict regulations that will help you narrow down your choice. In fact, your employment situation may take the burden of choice off your shoulders altogether.
Individual Retirement Account (IRA)
An Individual Retirement Account (IRA) is an investment plan that some people use to save without company involvement. You will often hear this particular type of account referred to as a “traditional” or “regular” IRA, as there are a few other variations.
Advantages of an IRA
If your company does not offer a 401(k) plan, an IRA can provide similar advantages, such as tax deferral on contributions if you qualify. You may also appreciate the ability to choose assets more freely than in a 401(k). While company-sponsored plans are typically managed by outside professionals, a traditional IRA can contain stocks, bonds, certificates of deposit and funds of your choice.
What to know before opening an IRA
While some investors may benefit from the freedom of choice an IRA offers, those who don’t know how to choose the right assets are prone to making mistakes. You should also know that there are other types of IRA accounts. Some other online resources do not make the necessary distinctions, which can cause confusion. When researching these types of accounts, always make sure you are reading about traditional IRAs.
Health Savings Account (HSA)
An HSA is intended to help you save for the medical expenses you’ll face in retirement. You are only eligible for this type of investment account if you have a high-deductible insurance plan. Withdrawals must be for qualified medical expenses if you want to avoid paying taxes when you withdraw them.
Advantages of an HSA
As with many other retirement accounts, the contributions you make to your HSA are tax-deductible. In addition, you won’t pay taxes on withdrawals as long as they go to pay for medical expenses.
Another advantage is that the government doesn’t force you to start making withdrawals once you reach a certain age, allowing you to keep your money growing longer. In fact, according to Forbes, it’s possible to transfer funds from an IRA to an HSA, thus avoiding the former’s mandatory withdrawal requirements.
Many HSAs even come with debit cards that allow you to pay with funds directly from the plan without having to go through the withdrawal process on your own.
Things to Know Before You Open an HSA
Not all health-related expenses can be withdrawn tax-free from your HSA. See the list of IRS-approved procedures here.
Depending on your situation, having a high-deductible insurance plan may not make financial sense, even with an HSA. If you get sick frequently, for example, what you pay in deductibles may outweigh the tax benefits you receive from the account. Be sure to work with a financial advisor to make sure this is not the case.
Education Savings Accounts
If you plan to save for your or your children’s education, there are a few accounts worth considering. Which one you choose will depend on factors such as how quickly you need the money and the type of educational expenses you are saving for.
Generally, these accounts require you to identify what is known as a “beneficiary,” who will ultimately benefit from the funds when you make withdrawals.
Standard/taxable investment account
For many people, the types of investment accounts mentioned above are more than enough to save for common life goals, such as buying a home, putting a child through college and retiring with money.
However, there are situations where the rigid rules of those accounts make them unsuitable. That’s where a standard brokerage account can come in handy.
Advantages of a taxable investment account
In a standard investment account, there are no contribution limits. If you have a $100,000 windfall and want to invest it all at once, you can. There are also no legal limits on what you can and cannot invest. Whether you want to invest in typical stocks, bonds and ETFs or more complex assets like options, cryptocurrencies and commodity futures, the world is your oyster.
Most other types of investment accounts require you to earn income when you make contributions. However, a standard account has no such stipulation. You can continue to invest well into retirement if you wish.
A standard brokerage account also allows you to make withdrawals at your leisure. You’ve invested $100,000 only to realize a few months later that you need $50,000? No problem. You can withdraw your funds as soon as you’ve sold your assets.
