Don’t you love it when people get adamant about something you should do? I just love a good article title which tells how you should be living life. Well normally I wouldn’t get so particular on people as finances are a very personal thing. A good plan for one can be the wrong plan for another but there are some constants I have picked up in my time as a financial adviser that I want to share. As I have told people over the years that one should seek their own personal financial plan which is unique and unlike their neighbor’s plan, there does happen to be some consistencies which most all of us should be doing. When it comes to structuring a good financial plan there are 5 types of accounts, I think all people should look into getting. This list is in no particular order and certainly is not definitive. This is MY list for MOST people.
A roth IRA is a type of retirement account which allows for post-tax contributions on a voluntary basis every year up to an IRS defined limit which currently sits at $6,000 for individuals up to age 50 and $7,000 for individuals over age 50. Now this idea of “post tax” is not all that exciting when you start as you experience zero tax benefit in the year you contribute to your Roth but all the benefits get stored up for you down the road in retirement. This account is the posterchild for delayed gratification with your money. No tax benefits on your smaller contributions when you put them in but as those contributions grow, the entire amount becomes tax free upon distribution. The best analogy I have ever heard on this is “would you like to be taxed on the SEED or the HARVEST?” If this all sounds too good to be true well just wait there is more! The money as it remains in the account over time, is sheltered from income and capital gains tax as these can take place over time as one holds a mutual fund or other type of investment. You also have the great fortune of not being required to distribute income from it at a certain age making it a great candidate for legacy planning as it becomes an incredible vehicle for handing down wealth to a next generation through inheritance. Now these accounts unfortunately are NOT for everyone. Some individuals and couples may make too much income to contribute as it is not allowable for those of us making in excess of $140,000 modified adjusted gross income (MAGI) or a couple making in excess of $208,000. Fidelity put out a study which showed more than half of all IRA contributions have gone into Roth’s. They are gaining steam from the Millennial generation as they are seeing wages increase much later in their careers as compared to previous generations. I’m sorry did someone say TAX-FREE?! Definitely makes the top 5 in my book.
This is the Roth IRA’s older brother. The great nature of this in many ways is that it is the opposite of the Roth and considered funded through tax-deferred contributions. So, for those who would like to get their tax breaks immediately the Traditional IRA is for you. The contribution limits per year follow the Roth so $6,000 per person and $7,000 for those over age 50. Now please understand that when I say Traditional IRA I really am also including any retirement account which offers savers tax-deferred income options, so other accounts which fall into this category would be 401k’s, SEP IRA’s, 457 deferred comp arrangements, 403b’s, etc. All of these have slight differences between them, but the goal is all the same and that is to provide tax-deferred contributions for the purpose of a future retirement. Now there are downsides to be aware of with these account types. Different from the Roth is the requirement to distribute income at some point in the future. Currently, the Required Minimum Distribution for Traditional IRA’s is age 72 which increased due to the new SECURE Act made law by Congress in 2020. This rule forces your hand to distribute income in retirement and with the opposite effect of the Roth from the tax standpoint. All income drawn out of the account (principal + interest) will be taxable to you. Why not take either Traditional or Roth? Utilizing both in a strategy helps to diversify your tax exposure in retirement and helps to provide more strategies to use for calculating your retirement income. Bottom line: Both are good!
Non-Qualified Investment Account
“Non-Qualified” is the technical term for “Non-Retirement”. These accounts may be my personal favorite for people because many people don’t know about them and almost everyone should put themselves in a place to have one during their lives. The practical value of this type of account is what I often call “long term savings”. This account is comparable to a savings account a bank would offer except for the nasty low interest rate experience banks are offering today, and for the foreseeable future. Now let’s be accurate here... you may hold investments in this account, but you won’t receive a guarantee on those investments similar to the FDIC guarantee a bank would provide. Now if one can get over that then the possibilities are fairly endless. Mutual funds, stocks, bonds, and other securities may be placed in these for whatever events life decides to throw us. You can save for college in these accounts, you can save for the down payment for your future home here, you can save for that once in a lifetime trip you deserve from suffering through 2020! The main downside here is to understand how taxes impact this which would likely be capital gains on investments and any dividend income created from your investments here. Unlike the IRA’s, these accounts do not have that favorable shelter from taxation like the others have. I would also caution those whose short term need for this money is within the next 24 months. Fluctuation of investments in that short term may derail your plans if you aren’t careful. One must also know they should take a more conservative approach to this account when it comes to choosing investments. This is money you likely expect to use in the short term, so you need to plan the investments to fit those goals. More often than not this means having investments which are less in the stock market and more in the fixed income markets. Talk to an investment adviser to understand this more.
Hey I didn’t say this was a sexy list of accounts we all need. The good ol’ checking account has stood the test of time and winds up as one of the top 5 I would recommend. This for most of us is the first account we ever open and we probably hold it the rest of our lives. These accounts should be the heart of our personal finances. The blood goes in the heart and the blood goes out. Some people hold great amounts of money in their checking and I just don’t think it was ever designed to be more than a bill paying account and a landing spot for our paychecks.... So use it that way! Deposit your excess cash into some other vehicle where it will be treated better. Now I would say the checking account is a great place for storing one’s emergency savings. If you want to put your three months of expenses/income into this account that is fine. Maybe that could go in your actual savings account or your Non-Qualified Investment Account but not much more than this should go into your checking.
What? Are you saying an actual piggy bank or are you being facetious? I am actually saying if you have kids you should get an actual piggy bank. This is totally for those who are raising children and interested in their children gaining wisdom when it comes to money. In our world today credit has largely dethroned cash as the most widely used form of purchasing stuff and though we have gotten great convenience from this we have lost some of the subtle benefits of good ol’ hard cash to make decisions with. With children they will see mommy and daddy swipe this magical card at Costco and all of a sudden, the store lets them walk out with a cart full of goodies. Yeah, that won’t come back to bite you will it?! For kids they need to see the value in money being a precious limited resource. When inclined to take them to a store and treat them to a toy or goodie, please hand them a “10” and let them know that toy needs to come under the 10 dollar bill you gave them. They will have to learn the lesson of finding 12 dollars’ worth of stuff and then having to put something back. Along with this should be the value of them saving their money for the future. Enter Miss Piggy! Get them counting coins just like you did back in the day. Let’s be honest you were going to throw those pennies away anyways so why not let them stand for far more in the minds of your children?
There is not one account out there that gives people the security and freedom of a comprehensive financial plan. Don’t think that getting these five accounts will make you arrive anywhere closer to your goals but this list, however, can be an indicator that you are on your way to building the structures to help you meet those goals.