All Retirement Investment Accounts Are Not Created Equal
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Retirement investment is how you prepare yourself financially for "life after work". I'm sure you're like me...you envision living a life of luxury, not digging through your couch for change.
Definitely better than finding petrified french fries...
You'll rely on the same techniques, strategies, and brokers. You'll use the same types of investments. But your trading account will be different, and as you know, a different set of rules will change your investing process.
Add in the power of compound interest, and you can see why it is essential to start early and fund often when it comes to retirement.
What is a Retirement Investment Account?
These accounts are tools that will help you build a nest-egg to fund your adventures. Each account is similar to other brokerage accounts that you may own, with one important distinction: tax treatment.
And taxes WILL have an impact on your retirement investment plans and strategies.
Generally speaking, there are two categories of retirement accounts: Defined Benefit and Defined Contribution.
Defined Benefit Plans
These are commonly referred to as pensions. Your benefits are fixed (and supposedly guaranteed) as part of your employment contract. You "contribute" to the plan by working for the company for the required number of years.
Defined Contribution Plans
These are the accounts that you typically find in today's workplace. Your benefits are not defined. Instead, you define the amount you "contribute". Your employer may or may not contribute, and your benefits will be dependent on the amount of money you accumulate over your career.
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.