What are the best investment accounts for young investors? Though encouraged to invest for the future, which is good advice, the big question for many young adults is how to get started? The various types of investment accounts to consider can be somewhat confusing.
So, let’s sort that out:
Tax-Deferred Accounts
Retirement accounts can be tax-deferred. This means that the money invested in the account grows and compounds free of taxation year to year. Individual retirement accounts (IRAs) and company-sponsored retirement accounts, such as 401(k), 403(b), and 457 plans, are examples of tax-deferred retirement accounts, meaning that the money is not taxed until it is withdrawn during retirement.
In many cases, there is a tax break upfront when the money is contributed to these accounts. Workplace retirement plans allow you to make contributions from each paycheck. The contribution amount is withdrawn pre-tax, leaving less income to be taxed.
In the case of a traditional IRA, contributions are made in a similar fashion to a 401(k), with pre-tax dollars. An IRA or a 401(k) contribution might be one of the few tax breaks available for a younger worker, an added benefit for doing something you should be doing anyway.
Roth IRAs
A contribution to a Roth IRA is made with after-tax income—in other words, money on which you’ve already paid taxes. As with a traditional IRA or 401(k), the money grows free of taxes while invested. However, at retirement, the money can be withdrawn completely tax-free if certain rules are followed. Note that you can only open a Roth IRA account if your income is below a certain level. That makes these a good option for younger investors, as their income may be lower and the benefits of the current-year tax breaks are likely not as valuable as potentially higher earning future years.
While you miss out on a tax break during your working years, there is a big advantage to a Roth. Since your contributions will likely appreciate and earn interest over time, you can expect to have more in your account once you retire than just the sum of your contributions. That’s the whole idea of investing in the first place! So, when the time comes to start making withdrawals from your Roth, you don’t just get to take your original contributions out tax-free – you also won’t have to pay taxes on all the extra money you invested well.
Taxable Accounts
Taxable accounts can include brokerage accounts of various types, CDs, and some accounts with mutual fund companies. Gains and interest from these accounts are taxable each year as incurred. Losses may also be deducted in many cases. With a taxable account, you generally have greater access to your money without the worry of potential withdrawal penalties that may come with a tax-deferred or Roth account. Having this type of account can be extremely beneficial for those who have much nearer goals than retirement.
Brokerage Account vs. IRA
It can be difficult choosing which type of account is right for you, but in most cases, you can have both! IRA’s, as the name implies, are for your retirement, and generally ONLY for your retirement. But what about the short-term goals like buying a house, a car, or any large purchase. The good news is that you can have both of these accounts, and allocate your savings appropriately between them. This way you’re saving for the short term and the long term.
It’s important to know that all accounts have their advantages and drawbacks, and they’re each individually created for different purposes. The problem for most investors is that it’s not always easy to know which account types to open, since there are so many, and everyone’s situation is different. That’s why the job of a financial advisor like Demand Wealth exists. We help you understand how to invest, where to invest, and what accounts to open.
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Knowing where to start can be difficult and confusing! We are here to guide you onto the correct path for your investing future. Click here to open an account or to learn more, schedule a zoom with one our advisors today.
This report is a publication of Demand Wealth. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change.