Retirement Investment Accounts
Are Not Created Equal
Retirement investment. This is supposed to be how you prepare, financially, for "life after work". Not so long ago, that meant a life of comfort, relaxing on a beach, golfing...living the good life.
It definitely did NOT involve digging through your couch for change.
Definitely better than finding petrified french fries...
These days, a lot of people don't see how they can retire. The concept is so far off and/or out-of-reach, that they just put it out of their mind and figure they'll "cross that bridge when the come to it".
Unfortunately, when it comes to retirement, the best time for most people to start is yesterday. And human beings are terrible at long-term planning, which makes it really hard to truly appreciate the power of compound interest.
The good news? The second best time to start is today. And the first step is setting up a retirement investment account.
What is a Retirement Investment Account?
These accounts are very similar to other brokerage accounts, but have one critically important advantage: taxes!
Generally speaking, there are two types of retirement plans:
Defined Benefit and Defined Contribution.
Defined Benefit Plans
This is what you'd call a pension. The rules regarding the benefits from your employer are fixed as part of your employment contract (i.e. your retirement payouts are predefined.
You contribute to the plan by working for the company for the required number of years (i.e. vesting period). When the time comes (you reach retirement age as defined by your plan), you receive payments from your employer.
Defined Contribution Plans
These are the accounts you'll typically see these days. And there are several different types, depending on whether you're employment situation:
The rules regarding contributions from you and your employer are fixed by the type of retirement plan and the associate rules from the IRS (i.e. employer matching levels, maximum contribution levels are predefined).
You contribute pre-tax dollars, up to the allowable limit. When the time comes (you reach retirement age as defined by the IRS), you make withdrawals from your account.
Safe Investing Tip:
Since all retirement accounts get their advantages from the tax code, you must consult a tax advisor to make sure that you're not breaking any rules. No one likes an audit!
Advantages of Retirement Investment Accounts
Retirement investment accounts can help reduce your taxes now (e.g. pre-tax dollars are invested in a 401k) and/or in the future (profits within a Roth IRA are not subject to capital gains or dividend taxes).
Access to Full Service Brokers
Full service brokers usually charge higher commissions because they offer more information, tools, and a higher level of service.
Since your retirement accounts will most likely be "long-term", you won't be buying and selling investment instruments regularly. And that means lower commissions. So it could be economical to open a retirement account with a full service broker.
You'll gain access to all of their information, tools, and services. Then, you can use deep discount brokers for all of your other investing accounts and access your retirement accounts when you need to do some research.
Disadvantages of a Retirement Investment Accounts
Depending on your employment situation, the IRS limits the amount of money (pre and post tax) that you can contribute to your retirement accounts.
Limited Types of Investments
It's important to track your contributions, because over-contributing will result in penalties, confusing paperwork, and complicated tax documentation. Trust me on this one...
Mutual funds and ETF's have internal "management fees" which aren't removed directly from your account. Instead, these fees are removed from the return of the mutual fund/ETF.
Some investment brokers limit you to a certain number of trades within a period of time (e.g. 6 trades over a 1 month period). Additional trades cause holds on your account (i.e. you can no longer execute trades) or additional fees.
Unrelated Business Income Tax (UBIT)
This decreases the investing strategies at your disposal, and could cost you a lot of money if the market starts falling and you're locked out of your accounts.
The unrelated business income tax is triggered when a business that you invest using retirement account funds generates income for your account.
An investment broker is allowed, by law, to charge an annual fee for maintaining an IRA in your name. Most firms do not charge anything, but it is worth keeping an eye on just in case.
Some investment brokers (such as Fidelity) offer No Transaction Fee (NTF) trades on certain investment vehicles.
There is a catch though; you are required to hold the investment for a certain number of days. If you sell before a set date, then you will be charged the full commission fee.
How to Use Retirement Investment Accounts
Again, this is where you'll need the help of a financial or tax advisor. Each type of account has special requirements, allowances, and restrictions, so you'll need an expert to help you pick what's best for your retirement plan.
That said, investing in a retirement account still requires you to understand the rules that will dictate what you can and cannot do, and adjust your process accordingly.
Safe Investing Tip:
Municipal bonds give you tax-free returns, so do NOT buy them in a Roth IRA! Instead, buy them in a taxable account and take advantage of the tax savings.
Is a Retirement Investment Account Right for You?
The answer is always yes, but you have to plan properly. Everyone agrees that retirement investment accounts are a tool that you can use when you know the rules.
This page lists more disadvantages than advantages, but my goal was to arm you with information.
The tax advantages offered by retirement investment accounts is HUGE, and can easily make up for the seemingly large number of disadvantages.
But the jury is still out on whether accounts like the 401k can really take the place of a pension. It's a giant financial experiment being played with your money.
As retirees begin to rely more heavily on defined contribution plans, rather than the traditional pensions, the concept of retirement could change dramatically.