Back to the Basics: Investment Account Types

01.20.22 | Personal Finance

Which account is most appropriate for meeting your personal goals?  There are many account types with different features and benefits. Some may be more or less beneficial for you depending on your goals and your financial situation. For many investors the terminology and associated rules can be a bit confusing.  Below is a summary of the most common account types and their respective features.

Non-Retirement Accounts

After-tax investment account (also known as a “brokerage account”): this account type provides access to a broad range of investments, and you can contribute or withdraw funds at any age for any reason.  Any interest or dividends you earn on investments, as well as any gains on investments that you sell, are subject to taxes.  Capital gains on investments held for over one year are taxed at capital gains rates, whereas capital gains on investments held for less than one year are taxed at ordinary income rates.

Non-retirement accounts can be owned in multiple ways-

  • Individual brokerage account: Opened by an individual who retains ownership and has control of the account.
  • Joint with rights of survivorship: An account shared by two or more people — typically spouses, but it can be opened with anyone, even a non-relative.
  • Custodial account: An account set up for a minor (a person under the age of 18 or 21 years, depending on the laws of the state of residence). Typically, children under 18 are not eligible to receive assets so a custodial account will allow a parent or guardian to direct the account until the child is no longer a minor.

Retirement Accounts

The biggest differences between retirement accounts and  After-tax investment accounts are when you can access the funds and how contributions and gains are taxed. Depending on the type of retirement account you choose, you either receive a tax deduction in the year you make a contribution but pay taxes when funds are withdrawn (e.g., traditional IRA) or you don’t receive a tax deduction up front but qualified withdrawals are tax-free (e.g., Roth IRA).

  • Roth IRA: Contributions to Roth IRAs are not tax-deductible, but qualified withdrawals are tax-free. There are two criteria to meet for a withdrawal to be qualified: 1) the account owner must be 59.5 years of age or older and 2) the Roth IRA account has been open for at least 5 years from January of the year in which you made your first deposit.  The benefit to Roth IRA’s is the potential tax-free growth, which makes them very appealing to those who have many years until retirement and/or are in a lower tax bracket than they expect to be in retirement.

Be aware there are income limitations that  impact your eligibility to fund a Roth IRA. Contributions can be made up until the tax filing deadline of the tax year you are contributing to (for example, between January 1, 2022 and April 15, 2023 for tax year 2022).

  • Traditional IRA: Contributions to traditional IRAs are often tax-deductible, while earnings grow tax-deferred until withdrawn. Withdrawals from traditional IRAs are taxable as ordinary income.

Be aware there are income limitations that determine whether you are able to deduct your traditional IRA contribution. If you (or your spouse) have a retirement plan at work, the deductible portion of your traditional IRA contribution may be reduced or eliminated altogether once you hit a certain income. You can still make contributions, but they might not be tax-deductible.  Similar to Roth IRAs, contributions can be made up until the tax filing deadline.

  • Defined Contribution retirement plans (401(k), 403(b), 457): Many organizations offer defined contribution retirement plans to benefit their employees and help them save for retirement. The amount you can contribute to this type of plan is higher than an individual retirement account, and employers may offer a match or additional profit-sharing contributions if an employee participates in the plan.  Contributions to employer plans can only be made through payroll deferrals and must be made during the calendar year.

The IRA deductibility rules for traditional IRAs do not apply to employer plans; in other words, income phaseouts do not apply to employer plans.   People can contribute to both an employer plan and an IRA so long as they don’t exceed the annual maximum amount for each account type, and their income is under the phaseout limit (if applicable).

  • HSA: Health Savings Accounts are available to those who participate in an eligible High Deductible Healthcare Plan and the contributions are tax-deductible. The annual amount you can contribute to an HSA depends on whether are on a single or family healthcare plan, and the funds are tax-free if used for qualified medical expenses.

A unique feature of an HSA is that they can be used at any age as long as they are used for eligible healthcare expenses, and unused funds stay in the account for use in future years, unlike some other healthcare benefits.  Contributions can be made from your savings or from your paycheck. Much like an IRA, contributions to an HSA can be made up until the tax filing deadline.

Plan for a More Confident Financial Future

Midwest Capital Advisors can help you make the right financial decisions by taking the confusion and guesswork out of investing.  We work alongside you and provide educational tools and resources so you can understand what’s happening every step of the way and monitor it. Learn more about our financial planning process, or let us know if you have questions about our services.


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