Types of Brokerage Accounts

Choosing the right account type can save you thousands in taxes and help you reach your financial goals faster. Let's explore your options. [DEFINITION] Tax-Advantaged Account: An investment account that offers special tax benefits, such as tax-deductible contributions or tax-free withdrawals. ### Taxable Brokerage Account **How It Works:** - Open with any amount - Deposit and withdraw freely - Pay taxes on dividends and capital gains each year - Capital gains rate: 0%, 15%, or 20% (based on income) **Best For:** - Saving beyond retirement account limits - Goals before age 59½ - Building an emergency fund in stable investments - Flexible access to money [EXAMPLE] You contribute $10,000 and earn $500 in dividends. You'll owe taxes on that $500 this year, even if you reinvest it. If you sell a stock for $2,000 profit, you'll owe capital gains tax on that $2,000. ### Traditional IRA **How It Works:** - 2024 contribution limit: $7,000 ($8,000 if 50+) - Contributions may be tax-deductible - Investments grow tax-deferred - Pay ordinary income tax on withdrawals - Required Minimum Distributions (RMDs) start at 73 **Best For:** - People expecting lower tax rates in retirement - Those wanting a tax deduction now - Self-employed without workplace retirement plans [TIP] If your employer offers a 401(k) match, contribute enough to get the full match before funding an IRA. It's free money! ### Roth IRA **How It Works:** - Same contribution limits as Traditional IRA - Contributions made with after-tax dollars (no deduction) - Investments grow tax-FREE - Qualified withdrawals are completely tax-free - No RMDs during your lifetime **Best For:** - Younger investors expecting higher future tax rates - Anyone wanting tax-free retirement income - Long time horizons (decades of tax-free growth) [KEY] The younger you are, the more valuable a Roth IRA becomes. A $7,000 contribution at age 25 growing at 10% annually becomes $315,000 by age 65—all withdrawable tax-free! ### 401(k) and 403(b) **How They Work:** - Employer-sponsored retirement plans - 2024 contribution limit: $23,000 ($30,500 if 50+) - Often includes employer matching - Traditional (pre-tax) or Roth (after-tax) options **Best For:** - Maximizing retirement savings - Getting employer matching (free money!) - Higher contribution limits than IRAs [FORMULA] Value of 401(k) Match = Your Contribution × Match Rate If employer matches 50% up to 6% of salary: Contributing 6% gets you 9% total (6% + 3% match) [EXAMPLE] You earn $80,000 and contribute 6% ($4,800/year). Your employer matches 50% of contributions up to 6%, adding $2,400. That's an instant 50% return on your money! ### Specialized Accounts **HSA (Health Savings Account)** - Triple tax advantage: deductible, grows tax-free, tax-free medical withdrawals - 2024 limit: $4,150 individual, $8,300 family - Requires high-deductible health plan **529 Education Savings** - Tax-free growth for education expenses - State tax deductions in many states - Can now fund Roth IRA with unused funds (new rule) **UTMA/UGMA Custodial Accounts** - Investment accounts for minors - Irrevocable gift to child - Child gains control at 18-21 [EXERCISE] You're 30, earn $100,000, and can invest $15,000 this year. Your employer matches 401(k) at 100% up to 3% of salary ($3,000 match available). What's the optimal allocation? |ANSWER| First, contribute 3% ($3,000) to 401(k) to get the full $3,000 match. Then max out Roth IRA ($7,000). Use remaining $5,000 in 401(k) or taxable account. Total: $15,000 invested + $3,000 match = $18,000 working for you. [WARNING] Early withdrawals from retirement accounts typically incur a 10% penalty PLUS income taxes. The Roth IRA has an exception: you can withdraw contributions (not earnings) anytime without penalty. [SCENARIO] You're debating Traditional vs. Roth IRA. You're 28, in the 22% tax bracket, and expect to be in the 24%+ bracket by retirement. The Roth likely wins: pay 22% tax now on contributions rather than 24%+ later on a much larger balance. Plus, tax rates could rise over your 35+ year investment horizon.