After choosing your investment strategy, deciding on where to make those investments from is the next step.
For those of you new to investing here is a quick rundown of common accounts that you can use to save for retirement.
Non-Retirement (Taxable) Brokerage Accounts: This is where I have the bulk of my stocks currently, though this year I want to focus more on putting more money in tax-advantaged accounts. Although I will be using the dividend income produced by this account for financial independence/early retirement, the account isn’t technically a retirement account as it has no tax advantages like IRA’s and 401k’s. The big benefit to having this type of account is that I can withdraw funds (dividends and principle) at any age, whether that be once I’m 40 (and hopefully financially independent 🙂 )or even tomorrow if I need some extra cash to supplement my current income. As these types of accounts aren’t tax advantaged, there are no contribution limits.
401k: With the days of defined benefit pensions mostly over, the 401k has become the primary retirement savings tool for most people. These plans are offered through your employer and generally allow you to invest in various mutual funds/index funds. Some employers may even match your contributions up to a certain percentage, essentially giving you free money. Generally contributions to 401k’s are made with pre-tax dollars, meaning the contributions will be tax deductible when you put them in but will be taxed when you begin withdrawing them. However there are some plans that now offer a Roth version, meaning the money you contribute is made with after-tax dollars, which although won’t give you a tax break today, can be withdrawn tax-free when you retire. For 401k’s you can’t withdraw funds until you turn 55 or 59 1/2 depending on your situation. The contribution limit per year by the employee is $17,500 (employer matches don’t count toward the limit).
IRA’s: There are two primary types of IRA’s: Traditional and Roth. The traditional option work the same as most 401k’s with contributions being pre-tax dollars. The Roth is made with after-tax dollars. The main difference between IRA’s and 401k’s are that IRA’s are accounts you can start on your own whereas you must work for a company that offers a 401k plan to participate in that type of investment vehicle. The great thing with an IRA is that you have more freedom to invest the way you want. You can choose to invest directly with a mutual fund company and invest in their funds or you can open a brokerage account as an IRA, giving you the option to not only buy mutual funds, but also individual stocks and ETF’s. This is how I have my Roth IRA set up, as a brokerage account. Money put in traditional IRA’s cannot be accessed until you turn 59 1/2 without incurring an early withdrawal fee and paying taxes. For Roth accounts, you can withdraw the amount of your contributions (but not any earnings) anytime. All additional funds in Roth’s cannot be accessed until you turn 59 1/2 without incurring a penalty. The current annual contribution limit for all of your IRA’s combined (if you have multiple ones) is $5500.
So what’s my plan for using these different types of investment accounts?
Right now I invest in a combination of the 3, with the bulk of my portfolio in a taxable brokerage account (and my Loyal3 account which is structured the same way as taxable) made up of dividend growth stocks, the rest in a Roth IRA of more dividend growth stocks, and a small part in my Thrift Savings Plan (federal employee 401k) which is made up of index funds. My TSP account will be probably be rolled over into a traditional IRA once I leave the military so I can invest into stocks instead of just index funds.
What about you? What type of investment accounts do you use? Thanks for reading. 🙂