Simple guide to investing

Investing vs Savings

Savings accounts are a good way to sit on money if you don't care if it grows. Interest rates for bank savings accounts are extremely low. There's no risk and the government insures everything up to $10,000. So a savings account is great if you have  up to $10,000 you want to set aside for a rainy day. Investing, is how you make money off of your money.

The Taxman Taketh Away

Most of the different types of investment accounts differ on when and how the IRS is going to get their hands on our money.

Definitions:

The money we invest is called the principle and the investment income is the increase in value we receive from investing the principle.

The IRS will tax both the principle and investment income at some point.

Retirement Accounts

Retirement accounts are meant to be used when we retire so they designed and set up to be used only as retirement money. Not for houses, cars or tuition (except Roth IRAs. As such there are generally strict rules about when the money can used without suffering huge financial penalties. 

Generally, there are two types of retirement accounts, tax-deferred and not tax-exempt:

Tax-Deferred - 401K & IRA

Tax-deferred means you put the money in before you pay taxes on it and you don't pay taxes on any interest income as your balance grows. The taxman gets his taste when you retire and start to withdraw the money at which point you get taxed like it was income. For example: If start to take money out like you were earning the equivalent of $100,000/yr you will be taxed like you were earning $100,000/yr

401K

The 401K is an employer sponsored account so you can't get one without having a employer that offers one. Generally the employer will also match your contributions with some percentage match so it's like getting free money.

Traditional IRA

A traditional IRA (Individual Retirement Account) is a tax-deferred investment account like a 401K except you can get one without being sponsored by an employer. You also don't get the matching contributions but that's probably obvious. Anyone can signup for a Traditional IRA and it generally follows the same rules as a 401K

Tax-Exempt - Roth IRA

A Roth IRA is a retirement account but you make contributions to it with post-tax money. You don't get any tax advantages or deferrals right now but when you take the money out in retirement you don't owe anything. 

There is also an annual limit of $5500 that you can invest in a Roth IRA.

Which one should we go with?

Generally Tax-Exempt is best when you're young and not earning a lot. When you're in your 20s and earning $40,000/yr your tax bracket is so low that paying taxes on the money when you earn it will be paying less then paying taxes on it when you're old. At this point in our lives Tax-Deferred would be better as we're probably earning more than we'll be living off of come 70 so we'd pay less in taxes if we wait.

Saving for College

There are a number of options for saving for college. Two Tax-Exempt options are 529s and Roth IRAs.

529

529 plans are college savings accounts where you invest money after taxes and any interest incomes accrues tax-free. Kind of like Roth IRAs. Each state has it's own plan and you can sign up for any state's plan regardless of where you live. You can use the money in the account for any qualified college education expense (tuition, board, books, etc.)

Roth IRA

Roth IRAs can be also be used for college with some draw backs. There is a limit to how much you can invest in a Roth IR and any Roth IRA funds you use will be counted as income when it comes to figuring out financial aid.

Other Investing