There are two broad categories of plan types: qualified and non-qualified. Within these groups are a number of important accounts that can help you achieve your financial goals. If you know your account types, you can better understand the advantages and disadvantages. Let’s take a quick look at each one.
Traditional Individual Retirement Account (“IRA”)
IRA accounts are often the core account for retirement savings. Contributions are typically tax-deductible, which means made with pre-tax assets. This provides a tax benefit in the current year by lowering taxable income. IRA’s are not taxed on investment growth annually. Taxation on this account occurs at the time of withdrawal. At which time in retirement, the individual will be at a lower marginal tax rate.
401ks are offered through an employer. While there are important differences and similarities between IRAs and 401k accounts, the big benefit of a 401k is that your employer can also make contributions, helping you build up your retirement savings quicker.
Contributions into a Roth IRA are made with after-tax dollars. Therefore, they are not tax-deductible like a Traditional IRA. Withdrawals, however, are tax-free after five years (and other important age conditions are met), which can potentially have a dramatically positive impact on the plan. As of 2020, individuals can contribute up to an annual maximum of $6,000 if you are age 49 and under, and $7,000 if you are age 50 and above.
529 Savings Plan
If saving for post-secondary education, a 529 Savings Plan is a popular option. 529 plans are sponsored by states, not the federal government. You do not have to live in the state that sponsors the plan you choose, nor does your child have to go to school in that state. What set 529 plans apart from others is that contributions grow tax-free if they are used for college.
Cash Account (for investments)
The most important non-qualified account type to know about is the cash account. Unlike qualified plans, a cash account does not have tax advantages, but there are also fewer restrictions. The big benefit to cash accounts is the liquidity. You can pull money out of your account at anytime without a tax penalty. However, there may be short-term and long-term capital gains taxes to consider.
A general rule of thumb is to maximize, if appropriate to your situation, qualified plans in order to take advantage of the tax benefits, before making significant investments into a cash account.
Do you think you can benefit from one of these account types? Contact me for a consultation!
This website is for informational purposes only and is not intended to be specific advice or recommendations. For specific advice or recommendations you would need to meet directly with one of our advisers.