Types of Investment Accounts

1. Retirement Accounts

These tax-friendly accounts are designed specifically for building your nest egg. A 401(k) is a popular employee benefit, but you can open and fund an individual retirement account (IRA) on your own.

401(k)

This is an employer-sponsored retirement account that allows you to make pre-tax contributions straight from your paycheck—and your money will grow tax-free. Your employer might also add funds on your behalf. In 2024, you can contribute up to $23,000 ($30,500 if you're 50 or older). Contributions are tax-deductible, which can reduce your taxable income today, but you'll be taxed on distributions you take in retirement.

There's typically a 10% early withdrawal penalty for tapping 401(k) funds before you turn 59½. Once you turn 73, you'll have to take required minimum distributions (RMDs) every year.

Traditional IRA

A traditional IRA is like a 401(k) in that:

• Contributions may be tax-deductible.
• Investment gains, interest and dividends grow tax-free.
• Distributions are taxed as regular income.
• There's usually a 10% penalty for withdrawing funds before age 59½.
• RMDs begin at age 73.

Traditional IRAs also have lower contribution limits, but they can be a source of additional retirement income. In 2024, you can put in up to $7,000 across all your IRAs (or $8,000 if you're 50 or older). You can open an IRA through a brokerage firm, bank, credit union or mutual fund company.

Roth IRA

Unlike a traditional IRA, a Roth IRA is funded with money you've already paid taxes on. Your balance grows tax-free, and you won't be taxed on distributions you take in retirement. Withdrawal rules are also less strict. You can tap your contributions at any time, tax- and penalty-free. You can also withdraw investment earnings without paying taxes or penalties, as long as you're at least 59½ and have had the account for five years or more. RMDs do not apply to Roth IRAs (unless it's an inherited account).

Keep in mind that Roth IRAs have income phase-out ranges. You cannot contribute to a Roth IRA if:

• You're single and your annual earnings exceed $161,000.
• You're married filing jointly and earn more than $240,000.

2. Brokerage Accounts

Brokerage accounts don't have the tax breaks that retirement accounts offer, but there are other perks. They have no contribution limits or income caps. You can also withdraw your money, including earnings, at any time without penalty—and RMDs don't apply. However, you'll likely be taxed on investment gains during the year they're realized.

With a brokerage account, you can invest in stocks, bonds, ETFs, mutual funds and other securities. They're available through individual stockbrokers and online investment brokerages, or you can use a robo-advisor. These are online platforms that use algorithms to invest on your behalf.

3. Education Accounts

The following investment accounts are designed specifically for education expenses. Each one works a little differently, but both offer attractive tax benefits.

529 Savings Plan

A 529 savings plan allows you to set aside money for college, graduate school and K-12 tuition. You'll enjoy tax-free growth—and you won't pay federal income taxes on money that's used for qualified education expenses. Your state may also offer a tax deduction or credit for 529 contributions. Qualified expenses can include:

• Tuition and fees
• Room and board
• Books, supplies and other learning materials

The plan will be in your name with the child listed as the beneficiary. You'll retain control of the account, even after they turn 18. If they decide not to go to college, you can name a new beneficiary. These plans are offered through state programs. You can open one with a broker or directly with the state program or sponsor manager. There are no contribution limits, but each state limits how much you can contribute during your lifetime. That could be as high as $550,000.

Coverdell Education Savings Account (ESA)

A Coverdell ESA is similar to a 529 savings plan. Both allow your money to grow tax-free, and you won't pay federal taxes on withdrawals that are used for qualified education expenses—but there are some key differences:

• Coverdell ESAs typically offer a more diverse mix of investment options. That can include stocks, bonds, ETFs, mutual funds and real estate. (There are usually more narrow investment choices with 529 plans.)
• Coverdell ESA contributions are not eligible for state tax deductions or credits.
• The beneficiary can receive up to $2,000 in annual contributions.
• You cannot contribute to a Coverdell ESA if your income exceeds $110,000 (or $220,000 if you're married filing jointly).
• In most cases, the beneficiary must use account funds within 30 days of their 30th birthday.
• If the beneficiary passes away, funds must be distributed within 30 days. That could trigger an unwanted tax bill. Alternatively, you can name a new beneficiary who's under 30 years old.

4. Health Savings Accounts (HSAs)

An HSA lets you set aside funds to cover qualified medical expenses like copays, deductibles and coinsurance. There are three major tax advantages:

• Contributions are tax-deductible.
• Your money will grow tax-free.
• You won't be taxed on distributions that are used for qualified medical expenses.

You must be enrolled in a high deductible health plan to contribute to an HSA. In 2024, you can contribute up to $4,150 for an individual health insurance plan (or $8,300 if you have family coverage). Those who are 55 and older can kick in an extra $1,000. What's more, once you turn 65, HSA funds can be used for whatever you like—not just health care costs—but you'll be taxed on non-qualified distributions.

The Bottom Line

There are lots of ways to invest. Some investment accounts are geared toward retirement, while others are designed for education expenses or medical costs. Your investment strategy might include multiple accounts. The goal is to grow your money while minimizing your tax burden.

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