So you’re ready to start investing — that’s fantastic! Like most investors, you likely have some specific goals you want to tackle, and that’s a great place to start.
The key to achieving a financial goal (other than just getting started!) is making sure that the right investment vehicle is paired with the right goal. Each account type has different tax advantages, regulations, withdrawal limitations, and income and age restrictions. Let’s walk through each of the three main account types we offer, as well as some situations in which each might be useful — and remember, you aren’t limited to just one account if you have multiple goals to pursue.
Individual taxable account
An individual account is your most flexible option for investing and saving for things like travel or major purchases — goals you want to achieve prior to retirement, like a new car, a down payment for a home, an emergency fund, etc. An individual taxable account is not qualified, which means you’ve already paid taxes on these dollars. As such, the only monies that are taxable upon withdrawal are capital gains, or what the account has earned at the time you liquidate, or withdraw all the funds.
Here’s an example: Say you invest $1,000, and the account has grown to $1,500 by the time you’re ready to liquidate. In this case, the taxable gain — i.e., the amount you’ll pay taxes on — is $500.
Traditional or Roth individual retirement account (IRA)
An IRA, whether traditional or Roth, is usually used toward the goal of retirement. These accounts can even be set up for specific goals that you want to accomplish in retirement and are a great supplement to your employer’s retirement plan. It’s important to remember, though, that you may have an early withdrawal penalty if you take a withdrawal before you turn 59 ½, so a decision like that likely warrants a larger discussion with your tax advisor.
The main difference between traditional and Roth IRAs is when they are taxed. A brief overview of each follows, but your tax professional is the best person to field questions for your specific situation.
Traditional IRA accounts use pre-tax money to invest, meaning the money in your traditional IRA is not taxed until it’s time to withdraw — usually when you reach retirement age. In most situations, you’ll have a great reduction in the amount you owe in taxes (sometimes dollar-for-dollar) by contributing to a traditional IRA, which is why so many are opened in tax filing season. A conversation with your tax professional would help determine if a traditional IRA makes sense for you.
Roth IRA accounts are another great way to diversify your tax situation in retirement. Unlike a traditional IRA, a Roth IRA’s contributions are made after taxes are taken out, so your withdrawals won’t be taxed later in life. In these situations, you’ll pay taxes at a lower tax rate than you anticipate having later in your career; these accounts work especially well for younger investors or individuals who find themselves in lower tax brackets. Keep in mind that because this is a tax-favored account, there are income restrictions that change annually, so you’ll want to watch for those.
No matter which type of account you choose, it’s wise to stay on top of annual changes from the IRS and to consult a tax professional before making any big moves.
Now that you have a better idea of the types of accounts available to you, it’s time to set some goals and start working toward them! Remember, we’re here to help — and if you want an easy, hands-off way to get started, check out our Online Investing platform, which offers automatic rebalancing and is a great way to dip your toe in investing and start working toward your goals your way.
We hope you found some of our tips helpful! This article is part of the Financial Planning, part of UBT's Five Principles of Financial Wellness Series.
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