Investment Account Types – What’s the Difference?

Ready to open an investment account? Great, what type? You mean I have to choose a type?! I thought I was doing a good job just deciding to open one!

It can be overwhelming to understand all of the different investment account types that exist. Don’t fret! We’re going break down the various accounts to hold your financial assets.

Taxable Investment Account Types

Individual Investment Account

This is an investment account for one person to open that is subject to capital gains taxes yearly with every sale of a financial instrument – stock, ETF, etc. Short term capital gains are owed on assets held less than a year, while long term capital gains are owed on assets held more than a year.

Contribution Limit: No limit on amount of contributions.

Joint Investment Account

This is an investment account for two people to open that is subject to capital gains taxes yearly with every sale of a financial instrument – stock, ETF, etc. Short term capital gains are owed on assets held less than a year, while long term capital gains are owed on assets held more than a year.

Contribution Limit: No limit on amount of contributions.

Custodial Account

This is an investment account for a guardian to open for a minor under the age of 18. They are established under your states Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA). The funds are the child’s from the moment they are deposited and can only be used for the benefit of the child even though the adult parent acts as the custodian/manager of the account.

Additionally, once the child no longer ceases to be a minor (dependent on the state but between the age of 18 and 21) they will gain full legal control over the account. Any income from the account belongs to the child. This means that if the income from sales results in over $1,000, a separate tax return/1040 must be filed for the child and they likely will owe some taxes. A state income tax return may be required too. There are also implications for college financial rewards/financial aid as they will take into account the assets of the child at a higher rate (20%) than assets of the parents (5.64%).

Contribution Limit: No limit on amount of contributions, however if these are ‘gifts’ from parents there is a limit that can be given by each individual before incurring gift tax.

Retirement Account Types

One common attribute for all IRAs and 401ks is that they are associated or ‘tied’ to a single named individual only – hence the “Individual” in “Individual Retirement Account.” Basically the importance of this is that the limits regarding how much you can contribute per year or at what age you can pull money out without a tax penalty is based on the individual who is named on the account.

Traditional IRA

A Traditional IRA is an account that you contribute money ‘pre-tax’ – so you take the tax benefit now – and the assets grow tax free (you don’t pay taxes every year on sales). At retirement age, you are able to withdraw funds from the account and only pay ordinary income tax. This means you get to decide how much you take out and therefore how much you will pay in taxes!

Contribution Limit (2019): $6,000 across all IRA accounts (for a single individual). This does not mean $6,000 for your Roth IRA and another $6,000 for your Traditional IRA. If you are 50 or over you can contribute an additional $1,000.

Roth IRA

Think taxes are going up in the future? Think you will make more money (withdraw more money) at retirement than you do now? If the answer to either of these questions is “yes” then a Roth IRA may be right for you.

With a Roth IRA, you pay ordinary income tax on all contributions (so you do not get the tax benefit now), but then the assets will grow tax free in the account (you don’t pay taxes every year on sales). At retirement, you can withdraw funds (both contributions and earnings) and pay zero taxes. This is quite an incredible opportunity because as you can see, the earnings that are created from the contributions incur no tax bill!

Traditional & Roth 401k

These are very similar to the two IRA types above except that they are offered as part of an employer sponsored plan. In many cases the employer may ‘match’ all or a portion of your contributions to your account. The contribution limits are much higher than the IRA options. The concept between Traditional vs Roth is the same though and many people choose to do a ‘mix’ of Traditional and Roth contributions as depending on your age, future tax rates compared to current tax rates, the performance of your portfolio, and your income at retirement it is not always easy to determine what option will be best for you.

Contribution Limit (2019): $19,000. If you are 50 or over you can contribute an additional $6,000.

Sep IRA

This is sort of like an employer sponsored retirement plan but for business owners and self-employed individuals. Contributions can only be made by the business owner and they have to be an equal percentage for each eligible employee as the owner is contributing for themselves.

Contribution Limit (2019): $56,000 or 25% of annual income, whichever is less.