Welcome to Part 1 of our Money Moves Investment Series with Certified Financial Planner Paula Swain. In this series, we’re diving deep into investment strategies for women, covering essential knowledge on how to build a secure financial future. In this post, Paula breaks down the types of investment accounts that every woman should know, especially those navigating life transitions such as divorce, career changes, or retirement planning.
Understanding the different types of investment accounts is critical to making informed decisions that align with your financial goals. Each account type offers unique tax advantages, growth opportunities, and levels of flexibility. Let’s explore these key account types and why they matter for your financial strategy.
1. Pre-Tax Accounts
Pre-tax accounts are one of the most commonly used investment vehicles for retirement savings. These accounts allow you to contribute funds before taxes are applied, which reduces your taxable income for the current year. Examples include:
- Traditional IRA: A tax-deferred retirement account that lets you contribute pre-tax dollars. The account grows tax-free until you begin withdrawing funds in retirement. Paula Swain explains, “When you withdraw money from a Traditional IRA after age 59½, it’s fully taxable as income. So, while you benefit from tax deferral during your working years, you’ll owe taxes on the entire amount you withdraw in retirement.”
- 401(k) or 403(b): Employer-sponsored retirement accounts that allow for pre-tax contributions, which reduce your taxable income today. Many employers offer matching contributions, providing an extra boost to your savings.
Why Pre-Tax Accounts Matter: These accounts are beneficial because they reduce your taxable income now, which can be especially helpful if you’re in a higher tax bracket today and expect to be in a lower one during retirement. However, Paula notes, “It’s important to consider whether taking the tax break now is more advantageous than planning for tax-free income in the future.”
2. After-Tax Accounts
After-tax accounts offer tax benefits later, rather than upfront. You contribute money that has already been taxed, but the advantage is that withdrawals during retirement are tax-free. Common after-tax accounts include:
- Roth IRA: One of the most popular retirement accounts, Roth IRAs allow your contributions to grow tax-free. When you withdraw funds in retirement, both the contributions and the earnings are tax-free, provided certain conditions are met. Paula highlights, “A Roth IRA is a powerful tool, especially for younger women or those expecting to be in a higher tax bracket later in life.”
- Roth 401(k): This employer-sponsored account combines the tax-free growth benefits of a Roth IRA with the contribution limits of a traditional 401(k). Unlike a Roth IRA, there are no income limits for contributing, making it an excellent option for high earners.
Why After-Tax Accounts Matter: These accounts provide tax-free income during retirement, which is particularly useful if you expect to be in a higher tax bracket when you retire. Paula emphasizes, “With historically low tax rates, Roth IRAs are a great option for many women, especially those who anticipate their income growing over time.”
3. Non-Qualified Accounts
Non-qualified accounts, often referred to as taxable or brokerage accounts, provide more flexibility but don’t offer the tax advantages of retirement-specific accounts. Money in these accounts is taxed at capital gains rates, which are often lower than ordinary income tax rates. Examples include:
- Brokerage Accounts: These allow you to invest in stocks, bonds, mutual funds, and ETFs. There are no contribution limits, and you can withdraw funds at any time. However, you will pay taxes on dividends, interest, and any capital gains. Paula notes, “Brokerage accounts don’t offer tax benefits like retirement accounts, but they provide liquidity and flexibility, which can be advantageous for medium- and long-term goals.”
- Non-Qualified Annuities: These allow for tax-deferred growth but are funded with after-tax dollars. Only the gains are taxable when you start receiving payments in retirement.
Why Non-Qualified Accounts Matter: While these accounts don’t have the tax perks of IRAs or 401(k)s, they offer liquidity and flexibility. “A brokerage account is taxed differently, but it’s an often-overlooked component of a diversified portfolio,” Paula says. These accounts are useful for goals like saving for a child’s education or building a travel fund.
Why You Need All Three Types of Accounts
Each account type offers unique benefits, and the key to a robust financial future lies in diversification across these accounts. Paula explains, “It’s not just about contributing to your 401(k) or IRA—there’s power in having money in different types of accounts, each taxed differently. This gives you options when it comes to withdrawing money in retirement.”
Here’s why it’s beneficial to have all three types of accounts:
- Flexibility in Retirement: Having money in multiple account types allows you to withdraw funds in the most tax-efficient way. You can withdraw from pre-tax accounts like a 401(k) early in retirement and switch to tax-free Roth withdrawals later when tax rates may be higher.
- Tax Planning: Diversifying your savings across pre-tax, after-tax, and non-qualified accounts lets you optimize your tax strategy both now and in retirement. Paula notes, “If you need extra income for a big purchase or vacation, pulling from a Roth IRA or brokerage account helps avoid additional taxes.”
- Liquidity for Life Events: Non-qualified accounts provide liquidity, which can be essential for life events such as buying a home, funding education, or handling unexpected expenses without penalty.
Conclusion
Having a mix of pre-tax, after-tax, and non-qualified accounts allows you to build a tax-efficient, diversified portfolio that can adapt to your changing needs. Whether you’re navigating life transitions like divorce, retirement, or career changes, understanding the role of each account type will help you maintain control over your financial future.
Part 1 of our Money Moves Investment Series has explored the basics of these investment account types. Stay tuned for Part 2, where we’ll discuss investment strategies for women in life transitions.
If you have questions or need personalized advice on how to implement these strategies, reach out to Paula Swain for expert guidance.
Contact Paula Swain
Certified Financial Planner, Financial Center for Women
Email: paula@financialcenterwomen.com
Phone: (734) 738-6300, Option 1
Website: financialcenterwomen.com