Investment Accounts

How to Choose the Right Investment Accounts for Your Financial Goals From 401(k)s to 529s, investment accounts vary in purpose. Learn the differences and which are better suited for your different long-term financial goals. Investment accounts are valuable tools for reaching your long-term financial goals. But they’re not all the same. Choosing the right investment account – or mix of multiple account types – could mean reaching your goal ahead of schedule, or having more finances to work with. But choosing the wrong account type could mean your money isn’t available when you need it. The right investment account depends on your plans for the future. Maybe you’re thinking about retirement or saving for your child’s college education. Perhaps you’re trying to pass on as much of your assets to your loved ones as possible. Or you might just be trying to earn more interest than you could expect from a traditional savings account or certificate of deposit (CD). Knowing your goal is the first step to choosing the right investment account. In general, you’ll end up with one of five basic types of investment account: IRAs, which are tax-advantaged accounts used by individuals and married couples to save for retirement. 401(k)s, which are accounts offered by employers that have a similar goal (retirement) and tax advantages as IRAs but relatively higher contribution limits. Health Savings Accounts (HSAs), which enjoy triple the tax advantages and can be used for retirement under the right circumstances. Individual (or Joint) Brokerage Accounts, which lack tax advantages but are available to virtually anyone for any investment purpose. 529 plans, which are tax-advantaged accounts that let individuals save for their own or a loved one’s education expenses. Each of these investment accounts is designed with different objectives in mind. Some are more liquid than others, giving you greater flexibility to withdraw money when you need it. Some come with tax advantages. Some have rules and restrictions for when (and how much) you can contribute to them. Or eligibility requirements that determine who can contribute to them. But you don’t have to have an MBA or work in finance to understand the different choices you have. In this guide, we’ll show you how identifying your goal helps narrow your options. Focus first on your investment goal Investment accounts come in many different forms, but you don’t have to learn the intricacies of them all. Before you choose where to put your money, you should have a clear understanding of what you’re trying to do with it. Starting with a financial goal in mind immediately narrows your options and keeps your decision rooted in your desired outcome. Here are some of the most common goals people have when opening an investment account. Planning for retirement When it comes to retirement planning, there are two main types of specialized retirement accounts to consider: IRAs and 401(k)s. HSAs can also be repurposed for retirement with some special considerations, which we’ll preview later. Retirement accounts offer unique tax advantages that can put you in a better position when you retire. However, you’ll usually incur penalties if you withdraw from these accounts before you reach retirement age. With either account type, you can control the ratio of securities (stocks, bonds, etc.) in the account, investment strategy, and more. Within each of these account types, there are also two main kinds to consider: Roth or traditional. First let’s talk about the difference between a 401(k) and an IRA, then we’ll look at Roth vs. traditional options. 401(k) A 401(k) is a retirement plan offered by your employer, also known as an employer-sponsored retirement account. If you invest in a 401(k), your contributions will be automatically deducted from your paycheck. One of the biggest advantages of a 401(k) is that employers will sometimes match a percentage of your contribution as an added benefit of employment, giving you money you wouldn’t otherwise have. If your employer offers to match 401(k) contributions and you don’t take advantage of that, you’re leaving money on the table and choosing to receive fewer benefits than some of your coworkers. 401(k)s also have higher contribution limits than IRAs. Every year, you can legally contribute more than three times as much to a 401(k) as you can into an IRA—up to $22,500 in 2023 if you’re under 50—helping you reach retirement goals sooner. When you leave your employer, you have to decide whether to leave your 401(k) funds with their provider, or roll them over to an IRA or a 401(k) offered by your new employer. Individual Retirement Account (IRA) An IRA works similarly to a 401(k), but your contributions don’t automatically come from your paycheck, and the annual contribution limits are lower ($6,500 if you’re under 50). Since an IRA isn’t offered through your employer, your employer won’t match your contributions to it. If your employer doesn’t offer a 401(k) or doesn’t match your contributions, an IRA can be an excellent choice to start retirement saving. Some investors choose to have both a 401(k) and an IRA to contribute as much as possible toward retirement through tax-advantaged means. The contribution limits are separate, so you can max out a 401(k) and an IRA if you can and are comfortable setting that much money aside every year. Roth vs. traditional The tax advantages of 401(k)s and IRAs come in two flavors: Roth and traditional. Contributions to Roth accounts are made with post-tax dollars, meaning Uncle Sam has already taken a cut. Contributions to traditional accounts, on the other hand, are usually made with pre-tax dollars. These two options effectively determine whether you pay taxes on this money now or later. Here’s another way of looking at it: Say you make $50,000 a year and contribute $5,000 to a Traditional retirement account, your taxable income is $45,000. You’re reaping the tax benefits of your retirement account now—and investing more than you may have been able to otherwise— in exchange for paying taxes on that money later. When you start withdrawing from your account, you’ll generally pay taxes on everything you withdraw, not just your original income. As a side note for high earners, the IRS limits deductions for Traditional IRAs based on income With a Roth account, you pay taxes on your contributions up front– meaning you potentially have less money to invest with–but enjoy the tax advantages later. If you make $50,000 a year and contribute $5,000, your taxable income is still $50,000. The earnings you accrue through a Roth 401(k) or Roth IRA are generally tax-free, so when you reach retirement age and start making withdrawals, you don’t have to pay taxes. As a side note for high earners, the IRS limits eligibility for Roth IRAs based on income. So, which is better, Roth or Traditional? The answer depends on how much money you expect to live on during retirement. If you think you’ll be in a higher tax bracket when you retire (because you’ll be withdrawing more than you currently make each month), then paying taxes now with a Roth account can keep more in your pocket. But if you expect to be in the same or lower tax bracket when you retire, then pushing your tax bill down the road via a Traditional retirement account may actually be the better route. Regardless, you should always consult a licensed tax advisor for the best information on your unique circumstances. HSA Designed primarily to help individuals pay for health care costs, HSAs can be an overlooked and underrated investing vehicle. That’s because your HSA contributions, potential earnings, and withdrawals (with a few key stipulations) are tax-free. This is what we mean when we say HSAs enjoy “triple” the tax advantages of IRAs and 401(k)s. In the case of those other two popular investment vehicles, you can catch a tax break on money coming in or going out, but not both. Learn more about how to use your HSA for retirement. Earning more from your savings Some people use investment accounts to simply help maximize the value of their unused income, or to save for major purchases down the road, like a home purchase or car. While a Cash Reserve account can work well for short-term financial goals, a general brokerage account lets you purchase stocks, bonds, exchange-traded funds (ETFs), mutual funds, and other financial assets that come with greater risk and the potential for greater returns. With a brokerage account, you need to decide if you want an individual or joint account. This choice basically comes down to who you want to have control over this account and what you’d like to happen with it when you pass away. It’s common for married couples to use a joint account to consolidate their resources and avoid the hassle of managing multiple accounts. But if you select a joint account, it’s important that you completely trust the other person, as their decisions and even their credit can significantly alter your financial assets. Creditors can sometimes claim funds from a joint investment account, even if the other person hasn’t contributed a dime. While general brokerage accounts offer a lot more flexibility than other investment accounts, they don’t provide tax advantages. If there are account types specialized toward your goal (like how IRAs are built for saving for retirement), they will likely have advantages over a general brokerage account. Saving for your own or a loved one’s education There are a lot of ways to save for education. But if you’re trying to make the most of your money, a 529 plan is an ideal choice because its earnings are tax-free, as long as you use them for qualified education costs. Your 529 plan doesn’t have to sit for a fixed period for you to start using it. As long as it’s applied to education-related expenses (tuition, room and board, books, student loan payments, etc.) for the beneficiary, you can withdraw from the plan as needed. The tax advantages and usage flexibility usually make 529 plans far more suitable for education planning than a simple savings account or a general brokerage account.

Should You Create a Trust Fund? It Could Help You Preserve Wealth Weigh the costs and benefits of establishing a trust as part of your estate planning. For those who have assets to leave as a legacy, a trust can be a strategic part of estate planning. Trust assets can include everything from a life insurance settlement and real estate to investments and cash. However, not all trusts are the same—there are many variations, each with specific benefits and restraints. In the past, establishing a trust was largely viewed as a tool for very high net worth individuals looking to preserve wealth across generations. But these days, easily accessible low-cost investing accounts help us all take advantage of the value that creating a trust can provide for our assets. One of the benefits of trusts is that they can shield assets from lawsuits and probate costs. Many are interested in these benefits regardless of their net worth. With the emergence of automated investing services, like Betterment, setting up and managing a trust account of any size is easier than ever. Selecting the right type of trust for your needs will be something to discuss with an estate planning specialist, such as a financial advisor, accountant, or estate planning attorney.1 However, there are some general benefits that most trusts offer. Below is a summary to help you decide whether a trust may be right for you. Privacy and Protection After an individual’s death, an estate typically goes through probate, where the will is open for public scrutiny and assets may be used to pay off creditors. If assets are held in multiple states (real estate, for example), probate will take place in every state—adding substantial costs to settling an estate. The costs associated with probate could reduce the estate by 3% to 7% on average—and that’s not including additional estate taxes and income taxes that may be due. These additional costs mean significantly less assets are given to the intended beneficiaries. With certain types of trusts, all assets that have been placed in the trust are considered property of that trust, and thus they are off limits to creditors, they’re kept out of public record, and they can avoid probate. Trusts are also a useful way to shield and protect assets for people who are at higher risk of litigation, such as doctors. Placing assets in a trust may also reduce the potential for lawsuits between heirs. Taxes Different types of trusts provide different tax advantages. For example, an irrevocable life insurance trust shelters any life insurance death benefit proceeds from estate taxes. The most popular type of trust is a revocable living trust, which is a trust that can be modified once it is established. It’s created during the grantor’s (the person who funds the trust) lifetime. On its own, a revocable living trust doesn’t provide specific tax benefits, but additional provisions can be added to these trusts to help reduce estate taxes. There are about nine commonly used trust types. Speaking with an estate planner and tax advisor will help you determine how to maximize tax advantages and establish the right type of trust for your needs. Distribution Control Not all beneficiaries need the same thing. A trust can establish guidelines for how and when funds are distributed. Rather than simply naming the person who will inherit your assets, you can add provisions that specify how the trust assets can be used. By adding these provisions to your trust, you can help your assets last longer, since you decrease the risk of a beneficiary draining the account for frivolous expenses. For example, funds might be earmarked for education, for special medical needs, or for distribution only after the beneficiary has reached a certain age. In addition, a trust can ensure—through its guidelines—that money is distributed in a specific way to a specific entity, rather than an individual. This might mean a charity, a religious institution, or your alma mater. Sound Investment Strategy A trustee is the person(s) named in a trust document who is responsible for making decisions regarding the trust. By law, a trustee has a fiduciary responsibility to oversee the funds entrusted to them. Regulation, such as the Uniform Prudent Investor Act, states that a trustee must act “prudently” when administering a trust, which means holding the investments in a sound interest-bearing account, as well as assessing the risk, return, and diversification of assets. Trustees can be an investment firm or an individual. Trustees should ensure trust assets are invested wisely to fulfil the specific aims of the trust.  Automated investment services like Betterment provide trustees with an easy, low-cost way to manage a trust. Consider the Benefits Whether you are looking for asset protection, privacy, tax minimization, control over how your beneficiaries use their inheritance, or a combination of each of these things—establishing and managing a trust has never been easier. After speaking with your estate planning specialist and determining which type of trust is best for you, check out our FAQ on what we offer for trust accounts here at Betterment. 1Note that Betterment is not a tax advisor and nothing in this blog post should be construed as specific advice—please consult a tax advisor regarding your specific circumstances.