In the big world of investing, it seems we hear a lot about what securities to invest in, but not as much about what types of accounts to invest in. There are so many different types of investment accounts, each covering a different purpose, and new types of accounts seem to be created weekly. What are some of the basic types of investment accounts and what can they do for you? This article covers some of the accounts that are available currently and why you would use each one.

Retirement Accounts

IRA stands for Individual Retirement Account. An IRA is meant for those who do not have access to employer sponsored retirement plans such as 401(k) plans or those who would like to contribute more than the maximum allowed by their employer plans. Why choose an IRA? Tax-deferred growth is the answer. With a standard savings account, you have to pay taxes on the interest or earnings that the account makes each year. An IRA, on the other hand, doesn't require you to pay taxes until the money is taken out in retirement, thus leaving more money in the account to grow each year. In many instances you can also deduct your IRA contributions on your taxes, giving you further tax savings. It seems like a small thing especially when the account balance is still small, but over time it makes a big difference. Investing $10,000 for 30 years in a regular savings account with a 28% tax bracket and a 6% average growth rate will give you $35,565 whereas that same amount put into a tax-deferred account will give you $57,435. Eventually, however, you do have to pay taxes on the earnings in your IRA, but you are still left with $44,153 after taxes are paid. Your net gain for tax-deferred growth is just over $8500.

Another individual plan is a Roth IRA. It is somewhat similar to a traditional IRA but the difference is that you cannot deduct the contributions and the earnings grow tax-free instead of tax-deferred. This type of plan is good for someone with a longer timeframe to invest or those whose tax bracket in retirement will be close to or higher than their current tax rate. Tax-free growth means that you don't have to pay taxes on any of the earnings in the account. If we start with $10,000 and invest it for 30 years at 6% growth like our example above, you would be left with $57,435. None of that money has to have taxes paid on it since the initial $10,000 already had taxes taken out and the earnings grew tax-free. Before you wonder why anyone would not automatically use a Roth IRA, consider the fact that the initial $10,000 investment wasn't tax deductible like it was for the traditional IRA above. With a 28% tax bracket, the Roth paid $2,800 on its initial $10,000 investment. If we look at the growth potential of $2,800 for 30 years in a tax-deferred account, it grows to $16,082. So, in this person's situation where their tax bracket is the same in retirement as it is while working with a 6% rate of growth, a Roth wouldn't be the best option. The Roth would only grow to $57,435 - $16,082 = $41,353 when all taxes are taken into consideration while the traditional IRA would grow to $44,153. There are several online calculators that can estimate which type of IRA would be to your advantage. Search under Roth vs. Traditional IRA for more information and calculators to determine the best account for you.

Page 1 of 3 :: First | Last :: Prev | 1 2 3 | Next