Before we look at each provider, let’s do a brief rundown of some of the major types of investment accounts that you will likely encounter at any firm. You will see there are many account types available, but many of them have to do with businesses, estates, and trust accounts – all of which will likely not apply to young investors.
STANDARD BROKERAGE ACCOUNT:
This is just your basic personal investment account where you are able to buy, sell, or hold basically any type of investment (though we’ve discussed why we should focus on stock investments). There are no limits to how much you can contribute to it and how and when you can withdraw money from it (unlike retirement savings accounts like 401k or IRAs). Any income received off of these “taxable” accounts like dividends and interest will be taxable to you. You will also be taxed on any gains you realize when you sell any investments that have appreciated in value. Most firms offer an “enhanced” brokerage account that comes with check writing capabilities. This can be a convenient feature, but generally, it may be best to keep a wall between your investments and cash reserves from your bank account so you don’t unintentionally overspend and draw down your investment assets.
TRADITIONAL IRA ACCOUNT:
The following several accounts are IRAs (Individual Retirement Arrangement) that are investment accounts designed for saving for your retirement outside of your work’s 401(k) plan. The Traditional IRA involves “pre-tax” contributions and withdrawals are taxed at your marginal income tax rate in retirement.
Generally, if your employer doesn’t offer a 401(k) program then it is wise to open either a Traditional or Roth IRA to begin saving for retirement. For those of us covered by a retirement plan at work then you will likely be unable to contribute to a Traditional IRA due to tax laws (however, you may be eligible to contribute to a Roth IRA).
For 2022 you are allowed to contribute up to $6,000 each year into your IRA account (whether it be Traditional or Roth – the combined limit is $6,000 across both types of accounts). If you withdraw money from this account without a qualified exception (permanent disability or select qualified higher education expenses for example) before you are 59.5 years old then you must pay a 10% penalty in addition to all income taxes. With Traditional IRAs you are required to start taking distributions once you turn 72, a feature that is not present in a Roth IRA.
ROTH IRA ACCOUNT:
Roth IRA contributions are made after-tax, and all of your withdrawals in retirement are tax-free. You can’t contribute to a Roth IRA if your income is above certain levels due to the tax advantages of these accounts. For 2022 for single tax filers if your income is over $144,000 then you can’t contribute to a Roth IRA, and if your income is between $129,000 – $144,000 then the amount you can contribute phases down from $6,000 to $0. The phase-out for Married filing jointly couples is $204,000 – $214,000. Another advantage to a Roth IRA in addition to the withdrawal tax benefits is that you have more flexibility in withdrawing money from the account before retirement. You are allowed to take out your original principal (the money you initially invested) at any time with no penalty, and you are not required to take money out of the account at any time in retirement.
ROLLOVER IRA ACCOUNT:
A “rollover” refers to when you leave an employer in which you had a 401(k) account, and then you choose to move that account from your employer’s plan into your own brokerage IRA account. Generally, if you are young and have had several jobs over time then it is wise to rollover your 401(k) into an IRA once you leave a job. This way you will have all of your accounts in one place and don’t have to call three previous employers to check up on your prior 401(k) investments. Or, you can just move your old 401k into your current 401k if your plan allows. This account type effectively operates the exact same as a Traditional IRA account, but it is titled to categorize the funds as previously being held in a qualified retirement plan like a 401k.
INHERITED IRA ACCOUNT:
These accounts are for the unfortunate case that someone close to you passed away and you were a beneficiary of their IRA account. You can either transfer the money into an Inherited IRA Account where you can withdrawal money at any time (no 10% early withdrawal penalty, but you must pay income taxes on the full amount of each withdrawal), take the money as a lump sum (and pay income taxes on it all), or if you are a spouse you can transfer it into your personal IRA account. Generally it is best to keep inherited IRA money in a tax-deferred status (ie keep it in an IRA) so it can keep growing tax-free and you can spread out the required distributions from the account and the resulting tax burden over time, but in this case it is best to consult a financial advisor or an estate attorney to review your options. If the inherited account doesn’t come from your spouse, you are required to begin annual withdrawals within one year from the date of death to enjoy lifetime deferral of taxes. Otherwise, it all must be withdrawn and taxes paid within five years.