Investing can be a scary blanket term used for so many different things we might not realize we're already doing. If you're contributing to your employer sponsored retirement account, you're already an investor so it's not a matter of starting to invest but rather being curious and learning more about where you can find efficiencies and and set up systems to make sure your money is working as hard as possible for you. That shift in mindset can help if you feel overwhelmed about where to start and any other insecurities that might prevent you from jumping in.
The Investing 101 article focused on a high level view of investing terminology and alluded to the fact that there are a few different investment accounts once you've settled on a brokerage or just use the same one where your existing retirement account is housed. Below are investment accounts and their tax advantages and considerations:
Traditional 401(k) and 403(b): these accounts are tax-deferred until retirement meaning you don't have to pay income taxes on it until you withdraw at retirement age (59½) because it's withdrawn from your paycheck prior to the IRS coming for their cut and can also help lower your tax burden as the contributions to this account are tax deductible. This means if your salary is $75,000 annually and you contributed $5,000 to your retirement account, you would report your taxable income as $70,000 versus $75,000. There are contribution limits every year and for 2024, you can contribute up to $23,000 and $30,500 if you're 50 or older. It's important to remember that those limits apply to all of your 401(k) account contributions (ROTH and Traditional). Be sure to be matching your employer contribution and that whatever that annual split is does not exceed the allowed contribution limits.
ROTH 401(k) and 403(b): these accounts work similar to traditional 401(k) and 403(b) with the exception that they are funded with after-tax contributions meaning you're paying taxes on your contributions before they hit your account so you're not paying taxes when you withdraw at 59½ but you're also not getting the benefit of lowering your income taxes now. It's important to note these contribution limits we just talked about apply to all employer sponsored retirement accounts so if you're splitting your contributions between ROTH 401(k) and Traditional 401(k), make sure the total doesn't exceed the IRS limit of $23,000 or $30,500 (for catch up). A rule of thumb I was always given when I first started contributing to my retirement account was to focus on ROTH first if I expected my income to be higher at retirement. I never cared too much for this advice as my immediate thought was "yeah, I hope I'm making more money in retirement than this entry-level salary that's barely enough to cover the essentials," but it also seemed like such an abstract concept when you're 20-something and retirement is last, if at all, on your list of priorities. But to keep things simple, make sure you're matching your employer's contribution and consider shifting strategies as your income increases to take advantage of the tax benefits a traditional employer retirement account allows.
ROTH IRA: unlike a traditional retirement accounts, a ROTH IRA is an individual retirement that works similar to a ROTH retirement account in that it is funded with after-tax dollars but has a different contribution limit of $7,000 as of 2024. Opening up one of these accounts through your preferred brokerage does not mean you are investing, you need to choose an investment within the account, not just transfer $7K and move on with your day.
Traditional IRA: as with a ROTH IRA, a traditional IRA is also an individual retirement account with tax benefits and considerations as contributions are tax deductible and you will pay income tax upon withdrawal at 59½. The contribution limit is $7,000 in 2024 for ANY IRA so if you're contributing to both a Traditional IRA and a ROTH IRA, ensure your combined contributions are not exceeding this total.
HSA (Health Savings Accounts): an HSA is sometimes referred to as a "triple threat" and "tax- advantaged" since your contributions reduce your taxable income (as with a traditional retirement account), your money isn't taxed while sitting in the account and you won't owe taxes upon withdrawal as long as the funds are used for eligible medical expenses. This is a great account that can help with tax burden as it does have higher tax advantages than other retirement accounts disused, but it does have limitations in what the funds are used for and the 2024 contribution limit is $4,150.
Individual Brokerage Account: unlike every other type of account reviewed so far, a brokerage account does not have withdrawal or contribution limits but it also offers no tax advantages and are subject to capital gains taxes, which are earnings on your investments. These are either long term capital gains taxes if the investments are held for one year or longer or short term capital gains if they are held for less than a year and long term capital gains are typically taxed at a lower rate than their counterpart.
Below is a quick cheat sheet for all these accounts:
To make your life easier, here's a way to prioritize these accounts since most of us can't contribute to everything all at once and still have some semblance of a life:
Retirement account up to employer contribution. ROTH or traditional will depend on your situation and tax advantages that make the most sense for you right now
HSA up to the contribution limit of $4,150
Retirement account up to the contribution limit of $23,000
Brokerage account as you feel comfortable contributing and increasing accordingly
Contribute what you can when you can and increase as you're able to and as your income increases, one step at a time.
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