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Investment Account Types: Here's What You Need to Know

Investment Account Types are the holding areas for your investment positions themselves. In the most simple form we can envision investment accounts as the ‘buckets’ or ‘baskets’ that we fill with our investment positions (holdings) when they are bought or transferred into the account. The different ‘Account Types’ create many different benefits as well as considerations for you to consider when deciding on what fits your needs best. Some examples include: “Retirement account”, “Investment Account”, “HSA/FSA Accounts”, and “529/Coverdell ESA Accounts”.

In today’s article, we will explore:

  • The 4 Major Investment Account Types
  • The benefits of each Account Type
  • Eligibility Requirements by Account Type
  • Considerations for each Account Type

1: Taxable, Brokerage Investment Account

Let’s say that you received some shares of stock as a gift, or you are looking to do some general investing not specific to a need such as retirement, educational (college) savings, or health savings. The brokerage investment account aka: “non-retirement account” is the most flexible & least restrictive in nature.

Eligibility Considerations:

The Brokerage Investment Account requires a legal Adult (at least 18 years or age) with a Social-Security Number (SSN) or Taxpayer Identification Number (TIN) to open an account. Other forms/proof of ID may be required by your local institution as well. There are no income or contribution limits for opening this account type.

Benefits of Non-Retirement Investment Accounts:

Brokerage accounts afford flexibility beyond what can be found in their retirement-based counterparts. For starters: there is no income limitations to who may use the account as a way to save and invest. This means that an investor will not become “phased out” of being able to save money in this account as their earnings grow; you should be aware of how increased earnings will impact the taxation of these funds when triggered though. Currently, taxable brokerage accounts are subject to capital gains taxes (taxes imposed only on the growth of the investment when sold) or interest/dividend activity. Based on the types of gain (long-term or short-term) and the interest/dividend types (tax-free interest v taxable & qualified v non-qualified dividends) will determine the ways these activities are taxed, allowing some levels of control to the investor. In addition to these means, losses on investments can be used to reduce or eliminate gains and their associated taxes.

2: Retirement Investment Accounts

Retirement investment accounts come in many different titles and may have different tax structures as well as rules associated with them. The one common theme between the accounts is the use and intent of the savings for retirement costs. As a result, one of the most common rules to these accounts is an inability to withdraw money from the accounts before the age of 59.5 without a penalty unless a qualifying exemption applies.

Common examples of retirement investment accounts include: 401(k), 403(b), SEP IRA, SIMPLE IRA, Solo 401(k), TSP, 457, Traditional IRA, Roth IRA. These accounts range between employer sponsored, self-employed or individual and have different rules, considerations as well as eligibility requirements.

Eligibility Considerations:

As previously mentioned, one of the first considerations is to understand what will apply to your unique set of circumstances. You will need to start with if you are employed by a company or self-employed, if the nature of your work is as a contractor (1099 income) or as an employee of the company itself (W2 income)? From there, you will be able to start with the options offered to or available to you in regards to your employment. You at the same time will be able to best assess if your goals benefit from what is available via those channels or if you are in need to save outside of those options. Employer or self-employed plans will require active employment and potentially a wait period or minimum hours worked depending on the plans. These plans do not have income thresholds but do require enrollment on your part and in most cases investment selection/oversight by you. For individual options such as Traditional or Roth IRAs there are income limitations and “Phase-outs” that are very important to be aware of.

Benefits of Retirement Accounts:

Retirement accounts offer a litany of benefits to their owners; from tax-deferral and shelter to tax-free future benefits. These accounts also may help to offset taxable income to avoid higher income brackets year over year. Another benefit of these accounts can come in the form of matching employer contributions see our previous post here to see the impacts.

3: HSA/FSA Accounts

There are many costs that we have to consider when budgeting and preparing for how to save; one of the most expensive can be medical costs. As a means to save for such expenses there are Health Savings Account (HSA) and Flexible Spending Account (FSA) options.

Eligibility Considerations:

Most employers who offer health benefits have options for FSA account enrollment. These accounts allow pre-tax money along with employer matches/deposits to fund the account for qualified medical expenses. The FSA account is a “use it or loose it” account that does not carry leftover balances into the next year. On the other hand, HSA accounts will carry balances forward for as long as the account is held. For HSA accounts you must be in a high deductible plan to qualify. The accounts can hold investments of your choice and offer additional benefits in retirement for account holders as well.

Benefits of HSA/FSA Accounts:

Outside of simply putting dedicated savings for medical expenses aside; both account types offer tax-free solutions for paying many common medical, prescription & over-the-counter expenses. In addition, contributions to these accounts can lower your taxable income. Finally, in the case of HSA accounts they may be used for Medicare premiums and after age 65 HSA funds can be used for non-medical expenses without the 20% penalty, only paying income taxes without RMD requirements.

4: 529 & Coverdell ESA Accounts

Tuition, room & board, textbooks: these are only a few of the college expenses to consider. There may also be goals that you have for private high school? There are accounts that benefit just those goals in mind. Note: Due to the expanded use of 529 investment accounts for pre-secondary education, trade school and college; Coverdell accounts by and large are sparsely used.

Benefits & Eligibility Considerations:

Accounts can be opened up for the benefit of an individual with a named custodian. There are contribution limits annually to keep in mind however, contributions can be made by family, friends or the custodian. Keeping focus on the 529 accounts: they may be transferred as far as a first cousin basis without penalty; the funds can also be taken up to the amount of awarded scholarship without penalty as well. Finally, the funds are tax-free when used on qualified educational expenses.

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