Posts tagged "types"

Where Should I Put My Savings? Different Types of Investment Accounts

Where Should I Put My Savings? Different Types of Investment Accounts

In the big world of investing, it seems we hear a lot about what securities to invest in, but not as much about what types of accounts to invest in. There are so many different types of investment accounts, each covering a different purpose, and new types of accounts seem to be created weekly. What are some of the basic types of investment accounts and what can they do for you? This article covers some of the accounts that are available currently and why you would use each one.

Retirement Accounts

IRA stands for Individual Retirement Account. An IRA is meant for those who do not have access to employer sponsored retirement plans such as 401(k) plans or those who would like to contribute more than the maximum allowed by their employer plans. Why choose an IRA? Tax-deferred growth is the answer. With a standard savings account, you have to pay taxes on the interest or earnings that the account makes each year. An IRA, on the other hand, doesn’t require you to pay taxes until the money is taken out in retirement, thus leaving more money in the account to grow each year. In many instances you can also deduct your IRA contributions on your taxes, giving you further tax savings. It seems like a small thing especially when the account balance is still small, but over time it makes a big difference. Investing ,000 for 30 years in a regular savings account with a 28% tax bracket and a 6% average growth rate will give you ,565 whereas that same amount put into a tax-deferred account will give you ,435. Eventually, however, you do have to pay taxes on the earnings in your IRA, but you are still left with ,153 after taxes are paid. Your net gain for tax-deferred growth is just over 00.

Another individual plan is a Roth IRA. It is somewhat similar to a traditional IRA but the difference is that you cannot deduct the contributions and the earnings grow tax-free instead of tax-deferred. This type of plan is good for someone with a longer timeframe to invest or those whose tax bracket in retirement will be close to or higher than their current tax rate. Tax-free growth means that you don’t have to pay taxes on any of the earnings in the account. If we start with ,000 and invest it for 30 years at 6% growth like our example above, you would be left with ,435. None of that money has to have taxes paid on it since the initial ,000 already had taxes taken out and the earnings grew tax-free. Before you wonder why anyone would not automatically use a Roth IRA, consider the fact that the initial ,000 investment wasn’t tax deductible like it was for the traditional IRA above. With a 28% tax bracket, the Roth paid ,800 on its initial ,000 investment. If we look at the growth potential of ,800 for 30 years in a tax-deferred account, it grows to ,082. So, in this person’s situation where their tax bracket is the same in retirement as it is while working with a 6% rate of growth, a Roth wouldn’t be the best option. The Roth would only grow to ,435 – ,082 = ,353 when all taxes are taken into consideration while the traditional IRA would grow to ,153. There are several online calculators that can estimate which type of IRA would be to your advantage. Search under Roth vs. Traditional IRA for more information and calculators to determine the best account for you.

In addition to individual plans there are also employer-sponsored plans. SEP IRA, SIMPLE IRA and Keogh plans are in between Traditional Individual Retirement Accounts and the standard employer sponsored plans such as 401(k)’s. SEP’s, SIMPLE’s and Keogh’s are for self employed individuals or small companies that need to put aside more money than a standard IRA allows but aren’t large enough to warrant the expense of a 401(k) plan. Each plan allows both employee and employer contributions. Each has set maximums between ,000 and ,000, depending on the plan and the contributor, and each has tax incentives for both the employer and the employee. These plans are great for small businesses to be able to set aside money for themselves and their employees and not have to go through the time and expense of larger employer sponsored plans.

The last type of retirement plans are employer sponsored plans. When it comes to retirement, it seems everyone knows the term 401(k). This is because a 401(k) is the retirement plan of choice for medium and large companies. In 2006, the maximum contribution to a 401(k) is ,000. If you are over fifty and your employer offers the 401(k) “catch-up” contribution, you can contribute up to ,000 more, so ,000 total. Your employer may also contribute to your 401(k) plan which generally doesn’t decrease your contribution allowance. Originally, 401(k) plans were only offered to for-profit companies. Those who worked for non-profit companies such as charities, schools, universities and hospitals weren’t able to contribute to 401(k) plans but were able to open 403(b) plans which allowed most of the same contribution limits as a 401(k). Government or public employees often used 457(b) plans for their contributions and for highly compensated employees there are 457(f) plans. This eventually changed to where 401(k) plans are now available to non-profit companies so more and more of the non-profit sector are opening 401(k) plans for their employees. Taxes on these types of plan can vary from one plan to another, so it is best to consult your plan director or talk with the investment company that manages your employers plan.

Education Savings Plans

Education plans have become available in the past decade allowing parents to better save for their children’s education. Instead of trying to set money aside in taxable savings accounts, parents can now setup an education savings account that has various tax advantages depending upon the type of account used. Choosing an education savings account depends upon what your long-term goals are for the money. There are three basic types of education savings accounts, IRC section 529 plans, the Coverdell Education Savings Account (CESA) and the Uniform Gift to Minors Account (UGMA). Each plan is tailored a little differently when it comes to its tax advantages and who gets the money from each plan, but each has the same general purpose, to save for your children or grandchildren’s future.

Medical Savings Accounts

There are three different types of accounts to help you save for healthcare costs, Flexible Spending Accounts (FSA), Health Reimbursement Arrangements (HRA) and Health Savings Accounts (HSA). The first of these, Flexible Spending Accounts are also called section 125 plans or “cafeteria plans.” This plan allows participants to put pre-tax money into the account each year to cover health insurance deductibles, co-payments, dental care and other medical expenses. Cafeteria plan money cannot accumulate from year to year, however, so it needs to be used up in one year or it will be gone. The second type of medical savings account is a Health Reimbursement Arrangement. It is similar to an FSA but the employer contributes to the account instead of the employee.

The employer can make contributions contingent on an employee participating in designated health and wellness programs. In June 2002 it was updated to allow funds to rollover from year to year, but it cannot be rolled over from employer to employer so if you change employers, you loose the accrued benefit. The last and most recently created plan is a Health Savings Account. This plan enables employees with high-deductible health insurance plans to set aside and invest money to use to pay the deductibles or other healthcare costs in the future.

These plans are designed to put healthcare decisions more into the hands of the employees. These plans are also portable so they move with you when you change employers and they can be rolled over from year to year.

Other Accounts

For those who are just looking to invest, a brokerage account is the medium to use. Brokerage accounts are setup through investment companies to allow you to purchase securities such as stocks, bonds, mutual funds, money markets, options, etc. Generally the money sits in a “core” account such as a money market until you are ready to invest it in other securities. There are fees for purchasing many securities which vary depending on the company that the account is setup with. Brokerage accounts can also offer check writing, debit and ATM cards for easier access to money in the account. Since there are no tax-advantages of a brokerage account, money can be withdrawn at any time from the core account. These accounts are perfect for additional savings that you want to invest in the stock market.

The standard savings account is probably what everyone is most familiar with. Offered by any bank, a savings account allows you to set money aside and receive a variable or fixed interest rate depending upon the account. Savings accounts are very liquid and can be withdrawn at any time, but they don’t allow check writing capabilities. Most savings accounts now days do offer ATM cards. Certificates of Deposit or CD’s are types of savings accounts that require money to be left in for a certain period of time in exchange for a slightly higher interest rate, these accounts are less liquid and there is generally a fee to take the money out before the predetermined period of time.

Whatever the reason or account used to set aside money, it is always a good thing. Savings in any form creates a more secure financial future and allows for problems or emergencies to be taken care of without having to obtain loans or dip into less liquid savings such as a home or other physical assets. Opening up any of the above types of accounts gets you started on the right track towards savings.

Related Sep Ira Articles

Roth IRA Conversions – Eligibility, Types of Conversions and Adjusted Gross Income Limits

Roth IRA Conversions – Eligibility, Types of Conversions and Adjusted Gross Income Limits

The Roth IRA is a better choice than traditional IRA because contributions are made after-tax adding greater tax leverage to your retirement savings allowing you to grow your savings tax-free and withdraw them tax-free! What happens if you already have a traditional IRA and would like to convert it to a Roth IRA? This is where Roth IRA conversions come into play!

Qualified Roth IRA Conversion

In order to successfully convert a traditional IRA to a Roth IRA, the conversion must be ‘qualified.’ Roth IRA conversions are treated as rollovers at all times, regardless of the method used. There are 3 of these methods, discussed below:

i) Rollover - You can take a distribution from a traditional IRA and roll it over to a Roth IRA within 60 days. To meet the 60 day rule, count the day you receive the check and include the day when you deposit the money into your Roth IRA. For example if you get the check on April 1st, 2010, you must have it deposited by May 30th, 2010. There is no extension granted for holidays and weekends.

ii) Trustee-to-trustee transfer - You can instruct the trustee of your traditional IRA to make a direct payment to the trustee of your Roth IRA. This is also considered a qualified rollover.

iii) Same-trustee transfer - If you have only 1 trustee for both your traditional IRA and your Roth IRA, you should instruct the trustee to transfer directly from traditional to Roth IRA.

Adjusted Gross Income Limits

The law states that if your adjusted gross income (AGI) is greater than 0,000, you cannot convert from a traditional IRA to a Roth IRA. This law applies to both singles, married filing joint & head of household filers. Note that if you are filing a married-filing-separate tax return, you are not eligible to convert a traditional IRA to a Roth IRA at all, no matter what your adjusted gross income is.

An interesting question asked is, what if you made a Roth conversion last January and find out that your adjusted gross income will exceed 0,000? If this happens, there is nothing to worry about. You can convert your Roth IRA back to a traditional IRA via a few simple procedures known as IRA Recharacterizations.

Example

John has an AGI of ,000. He also has a traditional IRA of ,000 that he would like to convert to a Roth IRA. John’s official adjusted gross limit (AGI) threshold for the year would be ,000. Note we do not include the ,000 conversion in the AGI limit because the law forbids that.

John has an AGI of ,000. He also has a traditional IRA of ,000 that he would like to convert to a Roth IRA. John’s official adjusted gross limit (AGI) threshold for the year would be ,000. Note we do not include the ,000 conversion in the AGI limit because the law forbids that.

Conversion Tax Effects

So you’ve decided to make a Roth conversion; there are some tax consequences you should consider before doing so. Funds converted from a traditional IRA to a Roth IRA that would have been taxable if the distribution had not occured as a ‘qualified rollover’ will be subject to income taxes at your current tax bracket. If your traditional IRA consists of prior deductible contributions (contributions that you have already deducted from your employment income to give you a tax break) will be taxed at the time of the conversion. Similarly, if your traditional IRA consists of prior non-deductible contributions (contributions that you have NOT deducted from your employment income to give you a tax break) will NOT be taxed at the time of the conversion.

Also note that if your IRA consists of funds from a prior rollover from another qualified retirement plan such as 401k, 403b plan, SEP plan, etc, all of the funds converted will be taxable at the time of conversion. Because the conversion you are making is ‘qualified’, there is no need for you to pay the 10% early withdrawal penalty, thus exempting you from that.

Employer IRAs and it’s types

Employer IRAs and it’s types

You can establish an employer IRA as long as you are in business and earn a profit. You don’t have to have employees working for you, and it doesn’t matter how your business is organized: You can be a sole proprietor, partner in a partnership, member of a limited liability company, or owner of a regular or S corporation.

The great advantage of employer IRAs is that you can contribute more than you can with traditional IRAs and Roth IRAs, both of which have lower annual contribution limits. And as long as you meet the requirements for establishing an employer IRA, you can have this type of IRA in addition to one or more individual IRAs.

SEP-IRA

SEP-IRAs are designed for self-employed. Any person who receives self-employment income from providing a service can establish a SEP-IRA. It doesn’t matter whether you work full time or part time. You can even have a SEP-IRA if you are covered by a retirement plan at a full-time employee job.

A SEP-IRA is a simplified employee pension. It’s very similar to an IRA, except that you can contribute more money under this plan. Instead of being limited to a ,000 to 00  annual contribution (2008), you can invest up to 20% of your net profit from self-employment every year, up to a maximum of ,000 a year in 2008. You don’t have to make contributions every year, and your contributions can very from year to year. As with other IRAs, you can invest your money in almost anything (stocks, bonds, notes, mutual funds).

You can deduct your contributions to SEP-IRAs from your income taxes, and the interest on your SEP-IRA investments accrues tax-free until you withdraw the money. Withdrawals from SEP-IRAs are subject to the same rules that apply to traditional IRAs. This means that if you withdraw your money from SEP-IRA before you reach age 59.5, you’ll have to pay a 10% tax penalty plus regular income taxes on your withdrawal, unless an execption applies. And you must begin to withdraw your money by April 1 of the year after the year you turn 70.

Simple IRAs

Self-employed people and companies with fewer than 100 employees can set up SIMPLE IRAs. If you establish a SIMPLE IRA, you are not allow to have any retirement plans for your business (although you may still have an individual IRA). SIMPLE IRAs are easy to set up and administer and will enable you to make larger annual contributions than a SEP or Keogh plan if you earn less than ,000 per year from your business.

SIMPLE IRAs may only be established by an employer on behalf of its employees. If you are a sole proprietor, you are deemed to employ yourself for these purposes and may establish a SIMPLE IRA in your own name as the employer. If you are a partner in a partnership. LLC member, or owner of an incorporated business, the SIMPLE IRA must be established by your business, not you personally.

Contributions to SIMPLE IRAs are divided into two parts. You may contribute:
up tp 100% of the net income from your business up to an annual limit – the contribution limit is ,500 for 2008 (,000 if you were born before 1955), and
a matching contribution which can equal 3% of your net business income.

If you’re an employee of your incorporated business, your first contribution (called a salary reduction contribution) comes from your salary, and the matching contribution is paid by your business.

The limits on contributions to SIMPLE IRAs might seem very low, but they could work to your advantage if you earn a small income for your business – for example, if you only work at it part time. This is because you can contribute an amount equal to 100% of your earnings, up to the ,500 or ,000 limits. Thus, for example, if you net earnings are only ,000, you could contribute the entire amount (plus a 3% employer contribution). You can’t do this with any of the other plans because their percentage limits are much lower. For example, you may contribute only 20% of your net self-employment income to a SEP-IRA or keogh, so you would be limited to a 00 contribution if you had a ,000 profit.

The money in a SIMPLE IRA can be invested like any other IRA. Withdrawals from SIMPLE IRAs are subject to the same rules as traditional IRAs, with one big exception: Early withdrawals from SIMPLE IRAs are subject to a 25% tac penalty if the withdrawal is made within two years after the date you first contributed to your account. Other early withdrawals are subject to a 10% penalty, the same as traditional IRAs, unless an exception applies.