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Aug 23, 2022

Types of Investment Accounts

By Stash Team
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Curious about investing but not sure what type of investment account to start with? From highly flexible brokerage accounts to tax-advantaged retirement plans to investing for your kids’ futures, almost every investor can find an account type that fits their needs. And you don’t have to pick just one. The key is choosing accounts that are right for your financial goals.

One thing to keep in mind: Investment accounts are not the same as savings accounts at a bank. The assets in any investment account could grow significantly over time, but investing always involves risk, including the risk that you could lose money.

In this article, we’ll cover:

Brokerage accounts

When people say “brokerage account,” they usually mean a highly flexible investment account that allows you to choose from many types of investments, trade the securities you want to own and withdraw money whenever you wish. Here’s an overview of how they work:

  • A brokerage firm, or broker/dealer, is a company offering financial services; you open your account with the brokerage, and they execute trades on your behalf. Brokerage firms come in many forms, from brick-and-mortar in-person service online-only platforms or apps. Your brokerage may offer other services too, like an online robo-advisor or financial advising.  
  • A broker is a licensed professional who can trade on your behalf. They work for a brokerage firm and typically charge a commission or other fees for helping to manage your money. You might not necessarily work with an individual broker at your brokerage firm; it’s common for people to use a robo-advisor or manage their investments themselves at online and app-based brokerages.
  • A brokerage account is the individual investment account you open with a brokerage firm. You put money into your account, and the brokerage invests it as you wish. If you want to buy or sell any securities, you request the trade and the brokerage enacts it.  If your account earns profits, dividends, or interest, you’ll likely owe taxes on that money 

A point of clarification: almost every type of investment account is held by a brokerage firm, even accounts with more restrictions, like an IRA or a custodial account. That’s because only brokers can interface directly with the stock market. They enable individual and institutional investors to buy and sell securities, like stocks, bonds, exchange traded funds (ETFs), mutual funds, and more. You interact with the brokerage, and the brokerage trades on the stock market on your behalf.

Cash account

Cash brokerage accounts are funded with your money: if you deposit $100, you can invest up to $100. In many cases, you can get started with just a few dollars. You can invest in whatever securities your brokerage offers; in addition to stocks, bonds, and funds, some brokerages offer access to commodities like gold and newer investment vehicles like cryptocurrency. 

Margin account

With a margin account, you can invest your own money, as well as borrow money from your broker to buy securities. You must pay back the loan, plus interest, even if your investments lose value. In some cases, the brokerage can force you to sell your investments to cover your debt. Margin accounts usually represent a significant risk to investors. 

Brokerage accountsKey facts
Who can open oneAnyone
How it's taxedNo special tax advantages. In some cases, profits may be taxed at the lower capital gains rate. 
Contribution limitsNone
Investment optionsUnlimited

>> Learn more about brokerage accounts 

Individual retirement accounts

Individual retirement accounts (IRAs) are tax-advantaged accounts that help people save for retirement. You can invest your contributions in almost any security, and investment returns grow tax-deferred while they remain in your account. There is typically a penalty for money taken out before age 59½, but there are a few exceptions. There are two main types of IRAs: traditional and Roth. 

>>Learn more about IRAs

Traditional IRA

With a traditional IRA, your contributions may be tax-deductible. This can reduce your taxable income, which might lower your overall tax bill in any given year. Any investment returns accrue tax-deferred and at 59½, you can begin making withdrawals. You’ll typically owe tax on the money you take out. If your tax rate is lower when you withdraw than it was when you contributed, you might reap tax savings. 

If you take out money before age 59½, you’ll have to pay an extra penalty tax unless you qualify for an exception. And when you turn 70½, you’re required to start taking distributions; you’ll owe additional tax if you don’t.

Key FactsTraditional IRA
Who can open oneAnyone with earned income, usually wages from a job.
How it's taxedContributions may be tax-deductible. Distributions after age 59½ are taxed at your current income tax rate. Distributions before that include an extra 10% penalty, with some exceptions. If you don’t take required minimum distributions after age 70½, you’ll owe more penalties.
Contribution limitsAs of 2022, $6,000 annually; $7,000 if you’re 50 or older.
Investment optionsVirtually unlimited; no life insurance or collectibles.

>>Learn more about traditional IRAs

Roth IRA

Unlike traditional IRAs, Roth IRAs are funded with after-tax dollars. Qualified distributions made after you turn 59½, however, are tax-free. That means any money you earn on your investments is also tax-free. If you expect to be in a lower tax bracket earlier in your career and a higher tax bracket close to retirement, a Roth IRA could help you save on taxes. Roth IRAs can also provide more flexibility when it’s time to withdraw, as you may be able to take out your principal investment without penalty prior to age 59 ½, and there are no required minimum distributions like traditional IRAs impose.  

Key FactsRoth IRA
Who can open oneAnyone with earned income and a modified adjusted gross income less than: $214,000 if married filing jointly or a qualifying widow(er). If you're single or married and filing separately, you must make less than $144,000 annually.
How it's taxedContributions are not tax-deductible. Qualified withdrawals are tax-free. Nonqualified withdrawals incur a 10% penalty tax plus income tax on investment returns. No required minimum distributions.
Contribution limitsAs of 2022, typically $6,000 annually; $7,000 if you are 50 or older.
Investment optionsVirtually unlimited; no life insurance or collectibles.

>>Learn more about Roth IRAs

Employer-sponsored retirement accounts

There are a few types of investment accounts offered by employers to help their employees with retirement savings. They typically offer tax advantages, and employers often make a matching contribution on your behalf. These retirement accounts usually have higher contribution limits than IRAs, but investment options tend to be much more limited.

>>Learn more about employer-sponsored retirement accounts. 

401K

A 401(k) plan is a retirement account that can be offered by private companies. Employees commonly contribute with pretax dollars, lowering their taxable income, though Roth and after-tax contribution options may also be available Employers may match employee contributions up to a certain amount, so many employees contribute at least enough to get the employer match. In many cases, these plans have a “vesting” schedule, meaning that employees do not fully own the employer’s contributions until they have worked there for a certain amount of time. 

Money in the account contributed on a pre-tax basis, including any investment returns, is not taxed until it’s withdrawn. If you expect to be in a lower tax bracket when you retire, you might save money on taxes. Funds withdrawn before age 59½ are subject to an extra penalty tax in most cases. Like traditional IRAs, 401(k) plans have required minimum distributions.

Key Facts401(k) Plan
Who can open oneEmployees of an employer who offers a 401(k).
How it's taxedPre-tax contributions are tax-deductible. Distributions after age 59½ are taxed at your current income tax rate. Distributions before that include an extra 10% penalty, with some exceptions. If you don’t take required minimum distributions after age 70½, you’ll owe a higher penalty tax.
Contribution limitsAs of 2020, $20,500 annually; if you’re 50 or older you can make a “catch-up” contribution of $6,500 annually.
Investment optionsDepends on the plan, but typically only a handful of mutual funds or exchange-traded funds.

Roth 401K

Roth 401(k)s have different tax advantages than standard 401(k)s. Like a Roth IRA, contributions to a Roth 401(k) are made with post-tax dollars, but qualified distributions are tax-free, including investment returns. If you expect to be in a higher tax bracket when you retire, a Roth 401(k) could offer substantial tax savings.

Key FactsRoth 401(K) Account
Who can open oneEmployees of an employer who offers a Roth 401(k)
How it's taxedContributions are not tax-deductible. Distributions after age 59½ are tax-free. Distributions before that include an extra 10% penalty, with some exceptions. If you don’t take required minimum distributions after age 70½, you’ll owe a higher penalty tax. If you want to avoid required minimum distributions on your Roth 401k balance, you can roll it over into a Roth IRA.
Contribution limitsAs of 2022, $20,500 annually; if you’re 50 or older you can make a “catch-up” contribution of $6,500 annually.
Investment optionsDepends on the plan, but typically just a handful of mutual funds or exchange-traded funds.

403(b)

Only private employers can offer 401(k) plans. Nonprofits and some government employers can offer a similar plan: the 403(b). 403(b) plans are also called tax-sheltered annuities.

Like 401(k)s, 403(b) plans allow you to make contributions of pre-tax money, and employers often offer matching contributions. You can generally take qualified distributions after age 59½, and will owe taxes on your money at that time; nonqualified distributions come with a 10% penalty. 403(b) accounts also have required minimum distributions.

Key Facts403(b) Account
Who can open oneEmployees of an employer that offers a 403(b).
How it's taxedContributions are tax-deductible. Distributions after age 59½ are taxed at your current income tax rate. Distributions before that include an extra 10% penalty, with some exceptions. If you don’t take required minimum distributions after age 70½, you’ll owe a higher penalty tax.
Contribution limitsAs of 2022, $20,500 annually; if you’re 50 or older you can make a “catch-up” contribution of $6,500 annually.
Investment optionsMutual funds and annuities

Custodial accounts: investment accounts for kids

A custodial account is a type of investment account for a child. A parent or other adult is the custodian; this person makes investment decisions and often funds the account. The assets in the account belong solely to the child, but the child cannot withdraw money until they reach the age of majority, which varies from state to state. Nevertheless, the account may be considered the child’s asset in financial aid calculations, potentially limiting the aid available to them. Additionally, any income from a child’s custodial account belongs to the child, so if income exceeds a certain threshold, you’ll need to file a separate federal income tax return for the child. The custodian, however, can use the money for the child’s benefit. 

>>Learn more about custodial accounts 

Uniform Gifts to Minors Act (UGMA)

UGMA accounts are custodial investment accounts that allow an adult to transfer assets to a child without establishing a formal trust. The account can contain stocks, bonds, and other securities. It’s managed by the custodian until the beneficiary reaches the age of majority; at that point, the beneficiary can use the money without restriction. Before that, the custodian can use the money for the child’s benefit. UGMA accounts will likely be treated as the child’s asset for purposes of financial aid, which might lower the amount of aid available. 

While UGMA investment returns are not tax-free, in some cases they are taxed at the minor’s tax rate, or the “kiddie tax,” which may be lower than the custodian’s. Contributions are made with post-tax dollars, but individuals can contribute up to $16,000, and married couples up to $32,000 per year, without triggering gift tax.

Note: UGMA is a federal law that states can adopt. While all states have done so, some have made amendments. You’ll want to learn the details of your state’s UGMA implementation before making investment decisions. 

Key FactsUGMA Account
Who can open oneAny adult
How it's taxedContributions are post-tax. Investment returns may be taxed at the “kiddie tax” rate.
Contribution limitsNone, but may trigger gift tax if they exceed $16,000 for an individual or $32,000 for a married couple annually.
Investment optionsVirtually any security, but no speculative investments like derivatives.

Uniform Transfers to Minors Act (UTMA)

UTMA largely aligns with UGMA: it allows adults to open a custodial account to transfer assets to children without establishing a trust, requires a custodian, may impact the child’s access to financial aid, and passes to the child without restriction at the age of majority. But UTMA extends UGMA to allow investments in more asset types, including real estate, paintings, patents, and royalties. UTMA also allows some flexibility for gifted assets to reach maturity dates, like bonds, even after the minor comes of age. 

UTMA is another federal law that states can choose to adopt. Most have adopted it, but not all, and some have amended it. It’s important to understand your state’s UTMA before making investment decisions. 

Key FactsUTMA Account
Who can open oneAny adult
How it's taxedContributions are post-tax. Investment returns may be taxed at the “kiddie tax” rate.
Contribution limitsNone as of 2022, but may trigger gift tax if they exceed $16,000 for an individual or $32,000 for a married couple.
Investment optionsVirtually any security

Custodial IRAs

Any individual can contribute to an IRA if they have earned income. Thus, children with earned income can fund IRAs to get a head start on retirement planning. Other people can contribute on the child’s behalf, as long as the total does not exceed the child’s earned income. A child’s IRA, however, must be set up as a custodial account.

Custodial IRAs can be traditional or Roth, and the contribution tax rules are the same as adult IRAs. For children, Roth IRAs can be especially attractive because contributions are made with post-tax dollars, at a time when a child’s tax rate is likely low. Then any investment returns grow tax-free, and any qualified distribution is also tax-free.

Key FactsCustodial IRA
Who can open oneAny adult, on behalf of a child who has earned income.
How it's taxedIdentical to non-custodial IRAs; rules differ for custodial Roth IRAs and custodial traditional IRAs.
Contribution limitsAs of 2022, $6,000 or the child’s taxable earnings for the year, whichever is less. Allowances or cash gifts from adults do not count as earned income.
Investment optionsVirtually unlimited; no life insurance or collectibles.

Investment accounts for education

The funds in UTMA and UGMA custodial accounts can be used for any purpose, though people often use those types of investment accounts to save for education. However, there are certain custodial investment accounts specifically designed for educational expenses: 529 college savings plans and education savings accounts (ESAs). These accounts offer special tax advantages, but they feature more restrictions on how the money can be used.

529 college savings plan

A 529 plan is a savings and investment account for college, K-12 education, and some apprenticeship programs. The most common type is the college savings plan; contributions can grow tax-free and be withdrawn tax-free for qualified educational expenses. The 529 prepaid plan, in contrast, allows adults to prepay in-state public tuition in hopes of locking in a lower rate. 529 plans are usually operated by states and can vary significantly from state to state. 

Key Fact529 Savings Account
Who can open oneDetermined by plan.
How it's taxedInvestment returns are not taxed, and qualified withdrawals are tax-free.
Contribution limitsWhile there are no annual contribution limits, each state imposes a lifetime contribution limit. You will need to consult the individual state’s plan for details. 
Investment optionsDetermined by plan.

Education savings account (ESA)

An ESA, sometimes called a Coverdell education savings account, is another type of investment account for educational expenses; the beneficiary must be under 18 or be considered “special needs.” The funds can be used for college or K-12 expenses. Contributions are made post-tax, but assets can grow tax-free, and distributions for qualified educational expenses are tax-free. Withdrawals made after the beneficiary turns 30 will incur penalties and taxes.

Key FactsEducation Savings Account
Who can open oneGenerally, anyone with a modified adjusted gross income less than $110,000 ($220,000 if filing a joint return).
How it's taxedInvestment returns are not taxed, and qualified withdrawals are tax-free.
Contribution limitsAs of 2022, $2,000 per beneficiary annually.
Investment optionsVirtually any investment except life insurance contracts.

Finding the right type of investment account for you

With so many types of investment accounts, it might seem daunting to decide which kind you want. They all have different levels of flexibility, potential tax advantages, and limitations. So it’s all about lining up your goals with the type of investment account that best supports them.

The good news is, that you don’t have to choose just one way to invest. It’s not uncommon for people to have one or more retirement accounts to take advantage of tax benefits, a brokerage account to grow money at a faster pace than inflation, and an account to save for their kids’ education. Investing can be a way to build wealth for the future, whatever your goals; with all the types of investment accounts out there, you can find the right approach for the future you want to build. 

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