Types Of Investment Accounts

What kind of investment account to you need? There’s a whole spectrum of different account types that are tuned to the goals people pursue when they invest—from growing a home down payment, to building a college fund or saving for retirement. Let’s take a look at your options when it comes to investment and retirement accounts for your personal finance journey.

Taxable Brokerage Accounts

Eligibility: Taxable brokerage accounts are available to anyone 18 years of age or older. Adults can open custodial brokerage accounts for investors under 18.
Investment Options: It depends on the brokerage, but generally you can invest in like stocks, bonds, exchange-traded funds (ETFs) and mutual funds.

You can invest on your own with a traditional brokerage account. They’re often referred to as taxable investment accounts because they lack the special tax advantages of certain retirement account types, such as a 401(k) or an individual retirement account (IRA). There are two main types of taxable brokerage accounts: cash accounts and margin accounts.

Cash Accounts

A cash account is probably the type of investment account you think of when you think about investing. You deposit money into a cash brokerage account, and then you use the funds to buy securities.

Cash accounts can meet the needs of most investors, but they do have certain limits that may be unappealing to more advanced investors. You need a different type of brokerage account to trade on margin or short stocks.

Margin Accounts

Margin accounts work the same as cash accounts, with two big advantages. They allow you to borrow money from your bank or brokerage to buy securities, a process called buying on margin, and they enable you to short trade, a risky speculative form of investing in which you bet on stocks and funds losing value—instead of gaining it.

In margin trading, margin accounts let you leverage your money with margin loans, which can effectively double the amount of securities you can buy. The cash and securities in your account serve as collateral for the loans, and you pay interest. Because you’re dealing with borrowed money, margin investing opens you up to much steeper losses than cash investing.

The other advanced investing technique margin accounts enable is short trading or short selling. With short selling, you borrow securities from other investors and institutions and then sell them, in the hope you’ll be able to repurchase and then replace them at a lower price. Because of the great potential for loss, federal law requires you to hold 150% of the value of what you borrow in a margin account as collateral.

Employer-Sponsored Retirement Accounts

To recruit and retain top talent, many companies offer employer-sponsored, tax-advantaged retirement investment accounts. According to the Society for Human Resource Management, 93% of U.S. employers offer a retirement savings plan.

If your employer is not among them, you’ve still got options for tax-advantaged retirement savings, which we describe below. Depending on your employer, you may have one or more of the following retirement account options available to you:

401(k) Plans

Eligibility: If your employer offers a 401(k) plan, it must be available to all employees 21 years of age or older who have worked for a company at least a year.
Investment options: Your employer is typically the 401(k) plan sponsor and is responsible for choosing the plan’s investment options. You may be able to invest in mutual funds, company stock and annuities.

With a traditional 401(k) plan, you make contributions to your retirement account with money that hasn’t been taxed yet. Your investments grow tax-free until you withdraw them in retirement. Then, they’re taxed at your current income tax rate.

Some employers will match a portion of your contributions, up to a percentage of your salary. Your company may match 100% of your contributions, for example, up to 5% of your salary. If you earned $50,000 per year and contributed $2,500 to your 401(k), your employer would add the full 5% ($2,500) to your account. If your employer offers a 401(k) match, you generally should make sure you’re contributing at least enough to get the full match.

An important note: Not all matching 401(k) contributions are immediately yours. About half of employers require some amount of “vesting” before contributions become fully yours. This means you have to stay at the company a set amount of time before you get to keep all of your employer match.

The 401(k) contribution limit for 2020 and 2021 is $19,500. Those who are 50 years of age or older can make catch-up contributions of $6,500.

Roth 401(k) Retirement Accounts

Roth 401(k) accounts are broadly similar to traditional 401(k) accounts but have different tax advantages. Contributions to a Roth 401(k) are not tax-deferred. Instead, you make contributions with money that’s already been taxed.

Your investment earnings grow tax free, and after age 62 ½, you can withdraw funds from your Roth 401(k) without paying income taxes as long as you made your first contribution to the account at least five years before.

The Roth 401(k) contribution limit for 2020 and 2021 is $19,500. If you’re 50 years of age or older, you can make catch-up contributions of $6,500 per year.

403(b) Retirement Accounts

Eligibility: If an employer offers a 403(b) plan, these investment accounts must be offered to all employees who work 20+ hours/week.
Investment options: Depending on your employer, you may be able to invest in mutual funds and annuities.

403(b) accounts operate similarly to 401(k) accounts. However, these plans are offered by non-profit organizations like churches, public service agencies and universities. Both traditional or Roth 401(b) accounts are available, each of which offers the same benefits as their 401(k) counterparts.

For 2020 and 2021, the contribution limit for 403(b) plans is $19,500. Employees who are 50 years of age or older can make catch-up contributions of $6,500.

SIMPLE IRA Retirement Accounts

Eligibility: Small businesses that don’t have other retirement plan options can offer these investment accounts.
Investment options: Investment options can include stocks, bonds, and mutual funds.

With a Savings Incentive Match Plan for Employees (SIMPLE IRA), the employer is required to make contributions to retirement investment accounts on behalf of their employees. The employer can choose to do one of the following:

Match employee contributions up to 3% of their compensation.
Contribute 2% of employees’ salaries to the plan, regardless of whether the employee contributes.

SIMPLE IRAs are not available as Roth accounts. With a SIMPLE IRA, the employee is always 100% vested, meaning you always have complete ownership of the total balance of your retirement account.

Only the first $290,000 in 2021 ($285,000 in 2020) of employee salaries can be considered for the employer contribution percentage.

SEP IRA Retirement Accounts

Eligibility: If a plan is offered, it must be made available to employees who are at least 21, earn at least $600 a year from the business, and have worked for the business at least three of the past five years.
Investment options: Employees choose their own investments. Options depend on your account provider but generally include stocks, mutual funds, ETFs, and certificates of deposit (CDs).

Typically, Simplified Employee Pension IRAs (SEP IRAs) are used by small businesses and self-employed individuals. With SEP IRA retirement accounts, only employers make contributions, not employees. If you’re self-employed, this distinction is meaningless as you are both employer and employee.

SEP IRAs have flexible annual contribution requirements and relatively low administrative costs. The biggest catch is employers must contribute the same percentage of employee compensation to all eligible employees’ SEP IRAs. This means the lowest paid employee must receive the same percentage contribution as the highest paid employee. SEP IRAs are not available as Roth accounts.

The contributions to a SEP IRA are limited to the lesser of 25% of the employee’s net compensation or $58,000 for 2021 ($57,000 for 2020).

Individual Retirement Accounts

If you’re not eligible for an employer-sponsored retirement account or want to supplement your retirement savings, you can open an Individual Retirement Account (IRA). Like 401(k)s, IRAs are available in traditional and Roth versions.

Traditional IRA Retirement Accounts

Eligibility: Anyone with earned income can open these retirement investment accounts.
Investment options: Depends on your account provider, but generally you can invest in a very wide range of securities, including stocks, bonds, mutual funds, ETFs, and CDs.

Traditional IRAs are tax-advantaged retirement investing accounts. Depending on your access to a workplace retirement plan and income, you’re generally able to deduct some or even all of your contributions from your tax bill. Contributions grow tax-deferred until you withdraw them in retirement. Then, you pay income tax on withdrawals based on your current income tax bracket.

For 2020 and 2021, the contribution limit for IRAs is $6,000, or $7,000 if you’re 50 or older.

Roth IRA Retirement Accounts

Eligibility: Income thresholds restrict who can contribute to a Roth IRA. You cannot directly contribute to a Roth IRA if you’re single and earned more than $139,000 in 2020 ($140,000 in 2021), or are married and earned more than $206,000 in 2020 ($208,000 in 2021). Note that people with incomes that are above these thresholds may still consider a backdoor Roth IRA conversion.
Investment Options: They depend on your account provider, but generally you can invest in stocks, bonds, ETFs, mutual funds, and CDs.

Like other types of Roth accounts, the contributions you make to a Roth IRA aren’t tax deductible today. However, earnings grow tax-free, and your withdrawals in retirement are tax-free as long as the account has been open at least five years.

Roth IRAs aren’t subject to required minimum distributions (RMDs), which are mandated minimal withdrawals you generally have to take from certain retirement accounts once you reach 72. This makes Roth IRAs particularly valuable. Roth IRAs also let you continue to add money to the account, regardless of age, as long as you earn income that qualifies.

The 2020 and 2021 contribution limits for a Roth IRA are $6,000 a year, or $7,000 if you’re 50 years of age or older.

Self-Employed Retirement Accounts

In addition to taking advantage of SEP IRAs or SIMPLE IRAs, which are described above, those who are self-employed can choose to open Solo 401(k)s, which can offer higher contribution limits than either self-employed IRA.

Solo 401(k) Retirement Accounts

Eligibility: Self-employed business owners with no employees (besides spouses who work at least part time) can open these retirement investment accounts.
Investment options: These depend on your account provider, but generally you can invest in stocks, bonds, mutual funds, and ETFs.

Solo 401(k)s are retirement investing accounts for self-employed individuals. A solo 401(k) functions a lot like a conventional 401(k), and is available in traditional and Roth versions. Crucially, with Solo 401(k)s, you can make contributions as both the employer and employee.

As an employee, in 2020 and 2021 you can contribute up to $19,500, plus an additional $6,500 for those over 50. As an employer, you can contribute up to 25% of your net compensation. All together your contributions cannot exceed $57,000 for 2020, or $63,500 if you are 50 or older. In 2021, this total rises to $58,000 or $64,500 if you are 50 or older. Contributions are deductible as a business expense or from your personal taxes, depending on if they are employer or employee contributions.

Education Savings Accounts

With college costs constantly rising, saving for tuition and other educational expenses can be crucial for many families. You have two options if you choose to use these investment accounts to save money for the education of your children or grandchildren, or even your own education expenses.

529 Savings Plan

Eligibility: Anyone over the age of 18 can open it for themselves or a child.
Investment Options: Determined by the provider but generally include at least diversified blends of mutual funds.

There are two kinds of 529 plans: prepaid tuition plans and 529 savings plans. The prepaid tuition plans are not investment accounts, but rather let you pay today’s tuition prices at in-state universities for a child’s education in the future.

529 savings plans are investment accounts you can use to save for your own or a child’s qualified education expenses. These might include tuition, fees, and room and board at any college or university as well as tuition for trade schools or private schools.

As long as withdrawals are used to pay for qualified educational expenses, they are not taxed. Notably, 529 plans can be assigned to new beneficiaries within the same family, so if one child didn’t use up all of their 529 funds (or didn’t choose to go to college), they can be reallocated to a younger sibling or even a parent.

529 plans are state-sponsored vehicles, and depending on your state of residence they may you offer certain tax advantages, like the ability to deduct some contributions from state taxes. You can open a 529 account in any state, regardless of where you live now. Doing so may allow you to invest in more preferable funds because some states’ investment offerings can be limited.

529 plans don’t generally have annual contribution limits, but they usually have total maximum contribution limits imposed by the state. These run anywhere from $235,000 to more than $520,000.

While they lack annual contribution limits, if you contribute more than $15,000 into one child’s account, you may incur a gift tax. To get around this tax, you can opt to contribute up to five times the annual maximum contribution ($75,000) if you don’t make any other contributions for five years.

Coverdell Education Savings Accounts

Eligibility: Your modified adjusted gross income must be less than $110,000 per year or $220,000 if filing a joint tax return.
Investment options: Determined by the provider but generally include individual stocks, ETFs, and mutual funds.

A Coverdell education savings account is a trust or custodial account set up to save for qualified education expenses for a designated beneficiary. Functionally, it works a lot like a 529 plan with broader investment options.

Notably, it can be used to pay for private elementary, middle, and secondary school expenses in addition to tuition. Like 529 plans, withdrawals used to pay for qualified expenses are tax-free. Unlike 529 plans, Coverdell accounts are not transferable to other family members.

Contributions to Coverdell accounts are not tax-deductible. The maximum amount you can contribute on behalf of one beneficiary is $2,000 per year in 2020 and 2021.

Health Savings Accounts

Eligibility: You must be enrolled in a high-deductible health plan (HDHP).
Investment Options: Most health savings accounts (HSAs) allow you to invest in mutual funds, though some also offer stocks and bonds.

A health savings account (HSA) can help you save for medical expenses today and in the future. To take advantage of a HSA, you have to have a high-deductible health plan. In 2020 and 2021, the IRS defines a high-deductible health plan as any plan with a deductible of at least $1,400 for an individual or $2,800 for a family.

Account contributions are made on a pre-tax basis or may be tax-deductible, and your earnings grow tax-free. Any withdrawals for qualified expenses are tax-free, making HSAs what’s known as a “triple-advantaged” investment option.

Unlike flexible spending accounts (FSAs), another popular health care savings account, HSA contributions roll over in their entirety from year to year. While you have to pay a 20% penalty and taxes on any withdrawals you don’t use for qualified medical expenses, after age 65, that 20% penalty goes away, making HSAs functionally like most non-Roth retirement investing accounts.

After 65, withdrawals made for non-medical expenses are simply taxed at your current income tax rate. You can also keep up with any eligible medical expense receipts and use them to reimburse yourself at any time, even years after a procedure or medication was paid for.

The maximum you can contribute to an HSA is $3,600 in 2021 ($3,550 in 2020) if you are contributing to an HSA just for yourself and $7,200 in 2021 ($7,100 in 2020) for families on high deductible health plans. This maximum includes any contributions your employer may give you.