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Investment Savings Account
Where Should I Put My Savings? Different Types of Investment Accounts
By Emma Snow
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.
In addition to individual plans there are also employer-sponsored
plans. SEP IRA, SIMPLE IRA and Keogh plans are in between
Traditional Individual Retirement Accounts and the standard employer
sponsored plans such as 401(k)'s. SEP's, SIMPLE's and Keogh's are
for self employed individuals or small companies that need to put
aside more money than a standard IRA allows but aren't large enough
to warrant the expense of a 401(k) plan. Each plan allows both
employee and employer contributions. Each has set maximums between
$6,000 and $30,000, depending on the plan and the contributor, and
each has tax incentives for both the employer and the employee.
These plans are great for small businesses to be able to set aside
money for themselves and their employees and not have to go through
the time and expense of larger employer sponsored plans.
The last type of retirement plans are employer sponsored plans.
When it comes to retirement, it seems everyone knows the term
401(k). This is because a 401(k) is the retirement plan of choice
for medium and large companies. In 2006, the maximum contribution to
a 401(k) is $15,000. If you are over fifty and your employer offers
the 401(k) "catch-up" contribution, you can contribute up to $5,000
more, so $20,000 total. Your employer may also contribute to your
401(k) plan which generally doesn't decrease your contribution
allowance. Originally, 401(k) plans were only offered to for-profit
companies. Those who worked for non-profit companies such as
charities, schools, universities and hospitals weren't able to
contribute to 401(k) plans but were able to open 403(b) plans which
allowed most of the same contribution limits as a 401(k). Government
or public employees often used 457(b) plans for their contributions
and for highly compensated employees there are 457(f) plans. This
eventually changed to where 401(k) plans are now available to
non-profit companies so more and more of the non-profit sector are
opening 401(k) plans for their employees. Taxes on these types of
plan can vary from one plan to another, so it is best to consult
your plan director or talk with the investment company that manages
your employers plan.
Education Savings Plans Education plans have become available in
the past decade allowing parents to better save for their children's
education. Instead of trying to set money aside in taxable savings
accounts, parents can now setup an education savings account that
has various tax advantages depending upon the type of account used.
Choosing an education savings account depends upon what your
long-term goals are for the money. There are three basic types of
education savings accounts, IRC section 529 plans, the Coverdell
Education Savings Account (CESA) and the Uniform Gift to Minors
Account (UGMA). Each plan is tailored a little differently when it
comes to its tax advantages and who gets the money from each plan,
but each has the same general purpose, to save for your children or
grandchildren's future.
Medical Savings Accounts There are three different types of
accounts to help you save for healthcare costs, Flexible Spending
Accounts (FSA), Health Reimbursement Arrangements (HRA) and Health
Savings Accounts (HSA). The first of these, Flexible Spending
Accounts are also called section 125 plans or "cafeteria plans."
This plan allows participants to put pre-tax money into the account
each year to cover health insurance deductibles, co-payments, dental
care and other medical expenses. Cafeteria plan money cannot
accumulate from year to year, however, so it needs to be used up in
one year or it will be gone. The second type of medical savings
account is a Health Reimbursement Arrangement. It is similar to an
FSA but the employer contributes to the account instead of the
employee.
The employer can make contributions contingent on an employee
participating in designated health and wellness programs. In June
2002 it was updated to allow funds to rollover from year to year,
but it cannot be rolled over from employer to employer so if you
change employers, you loose the accrued benefit. The last and most
recently created plan is a Health Savings Account. This plan enables
employees with high-deductible health insurance plans to set aside
and invest money to use to pay the deductibles or other healthcare
costs in the future.
These plans are designed to put healthcare decisions more into
the hands of the employees. These plans are also portable so they
move with you when you change employers and they can be rolled over
from year to year.
Other Accounts For those who are just looking to invest, a
brokerage account is the medium to use. Brokerage accounts are setup
through investment companies to allow you to purchase securities
such as stocks, bonds, mutual funds, money markets, options, etc.
Generally the money sits in a "core" account such as a money market
until you are ready to invest it in other securities. There are fees
for purchasing many securities which vary depending on the company
that the account is setup with. Brokerage accounts can also offer
check writing, debit and ATM cards for easier access to money in the
account. Since there are no tax-advantages of a brokerage account,
money can be withdrawn at any time from the core account. These
accounts are perfect for additional savings that you want to invest
in the stock market.
The standard savings account is probably what everyone is most
familiar with. Offered by any bank, a savings account allows you to
set money aside and receive a variable or fixed interest rate
depending upon the account. Savings accounts are very liquid and can
be withdrawn at any time, but they don't allow check writing
capabilities. Most savings accounts now days do offer ATM cards.
Certificates of Deposit or CD's are types of savings accounts that
require money to be left in for a certain period of time in exchange
for a slightly higher interest rate, these accounts are less liquid
and there is generally a fee to take the money out before the
predetermined period of time.
Whatever the reason or account used to set aside money, it is
always a good thing. Savings in any form creates a more secure
financial future and allows for problems or emergencies to be taken
care of without having to obtain loans or dip into less liquid
savings such as a home or other physical assets. Opening up any of
the above types of accounts gets you started on the right track
towards savings.
About the Author
Emma Snow is a writer who specializes in
financial planning. She has worked in the financial industry for
over eight years. Currently Emma works on a Finance and Investing
site at
http://www.finance-investing.com and Investing Partners
http://www.investing-partners.com
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