So you decided to dip your toes into investing your money to beat inflation and prepare for your financial independence. Not sure where to begin ? Does everything sound too complex and confusing? Well here is a guide that will help you to start your investing journey. This guide details what type of investing accounts exist, taxable, non-taxable and in what order should you go about investing money.
Types of investing accounts
1. Savings account/Emergency Fund
Do not start investing your money without having an emergency account. Investing is a long-term game. Its easily possible you may lose money in short term on paper. Investing needs a lot of patience but over time compounding and a good creates a nice retirement nest for you. Hence its important you have 6 months or more of your expenses saved for emergency. You can try the savings account from my previous post and still get 5% interest to beat inflation.
2. 401K/Employer Sponsored Plans
Many public employers in USA offer to match some % of your annual contribution to a retirement account. This account can be a 401K or a SIMPLE IRA which some employers provide. Examples can be employer matching 50% of your contribution at dollar to dollar up to 6% of your salary. Which means you get 6% more money in your 401K if you put 6% every year!
3. Individual Retirement Accounts
You can contribute up to 5500 USD in IRA accounts per year based on your annual salary and age. A traditional IRA allows you to claim your yearly contributions as tax deductions. You pay taxes after retirement when you withdraw money from this account. Roth IRA’s do not allow you to claim any tax deductions upfront, but you never pay taxes on any gains/withdrawals after retirement. However, these accounts have restrictions on when you can withdraw money and if you want it earlier, you pay penalty to access this money. Self-employed individuals have SEP-IRA which is like IRA’s for employed individuals.
4. Health Savings Account (HSA)
These are new breed of investing accounts. This is an option to you only if you subscribe to a high deductible health plan at work. They are also known as triple tax benefit account. The contributions are tax deductible, money withdrawn to pay for medical expenses is tax free. Any money you have after your retirement can also be withdrawn tax free for daily expenses! So ideally you never pay tax on the money in your HSA.
5. 529 College Accounts
These are investing accounts whose funds are meant to be used for college tuition, books and similar expenses. Most states provide one or the other form of these accounts. There are certain limits on if the money can be used in other places apart from college expenses. Some of these accounts also provide state level tax deductions.
6. Normal Brokerage Accounts
In addition to the above accounts, you can also have an account with any broker. Most brokers today open accounts online and allow you to buy sell securities for free or with some commission. These are usually taxable and you pay taxes on any gains you make when you sell securities in this account. You also have the ability to recognize losses if you have any in your tax returns form this account.
How do we go about investing now ?
- Obviously first you should have your emergency fund saved up!
- Next if you get any match from your employer in a 401K/SIMPLE IRA, I would suggest to make use of that since it’s just free money. Why leave it on the table. Make sure to contribute as much to get the maximum match from your employer.
- Next if you have more money left over, then try going for a IRA account. You can open them at any broker and broker usually tells you to not exceed the 5500 limit based on your profile. IRA usually gives you more options to invest your money than 401K’s.
- Still got more money to invest? Hot damn! Limits on 401k’s per year is up to 18500 USD. If you did not meet this limit in second point then it can be a good idea to contribute more money here. Alternatively, you can even contribute money to 529 college accounts or your HSA depending on your situation.
The above recommendations are just organized in a way to help you automate your investing/maximize returns and have the least tax bill. As you go on in your life, you do not want to bother about smaller details on these accounts. Most of these investing accounts usually work on autopilot. 401K’s usually only have mutual or index funds as options which you just buy and hold forever. So, it removes the decision making aspect and allows you to spend time on your hobbies or family. The only thing you need to make sure is you are not contributing more than the legal limits allowed per year. For more details on legal limits its best to look on government websites for respective plans.
Do you agree with these recommendations? What type of investing accounts do you use? Let me know in the comments below.