Comparing and Contrasting the Types of Investment Accounts

Our newest worksheet for The AAII Way is an inventory of your savings and investment accounts. It’s a document we think everyone should have. Considering it in the context of an overall investment policy statement will help you to understand why it’s being included in The AAII Way.

If you consider yourself to be an index investor or someone who is focused on costs, the list can be a prompt to take a look at what you’re paying in fees and costs. From the standpoint of ensuring your allocations are in line with your tolerance for risk and/or doing your periodic review, the account inventory serves as a useful checklist to ensure that you haven’t overlooked anything. From an estate-planning standpoint, an inventory of your accounts serves multiple purposes. It makes it easier for someone you trust to step in when you are no longer able to manage your own assets. It prompts you to review your beneficiary information. And it helps your heirs to settle your estate. On top of all this, you can find opportunities to consolidate and reduce the number of accounts you have.

There is certainly a lot of ground to cover. As we further develop The AAII Way, you’ll see some of these topics covered in more detail. Today, we’re going compare and contrast the types of investment accounts. It ties into the conversation of where you should hold certain investments (asset location) and helps you think about what constraints you may have, which plays into the rules you need to establish for managing your portfolio.

Taxable Investment Accounts—These are commonly thought of as brokerage accounts but can also be mutual fund accounts. Brokerage accounts give you the most flexibility in terms of what you can invest in (though transaction fees may make some mutual funds less desirable). Mutual fund accounts have the obvious constraint of being limited to the fund sponsor’s menu. Taxable accounts are most suited for strategies and investments with a low tax impact (index funds, municipal bonds, long-term holdings of stocks, etc.)

Individual Retirement Accounts—Traditional IRAs are funded with pretax dollars. Starting at age 72 (age 70½ pre-2020), required minimum distributions (RMDs) must be taken. Withdrawals are taxed at your marginal tax rate. A 10% penalty generally applies to withdrawals made prior to age 59½. When held with a brokerage firm there is a good amount of leeway with what you can invest in, though some constraints exist (see the More on AAII.com section below). There are limits on deductible IRA contributions ($6,000/$7,000 if age 50 or older) along with income phaseouts for higher earners. You can rollover a 401(k) and many other retirement accounts into an IRA. Because of their tax-preferred status, they can work well for strategies with higher levels of turnover and investments with a higher tax impact [e.g., real estate investment trusts (REITs), corporate bonds, etc.].

Roth IRAs—These are funded with aftertax dollars. Withdrawals—which are never required—made after a period of five years have no tax impact (presuming you meet the age requirements, generally age 59½ or older). When held with a brokerage firm there is a good amount of leeway with what you can invest in, though some constraints exist (see the More on AAII.com section below). There are limits on Roth IRA contributions ($6,000/$7,000 if age 50 or older) along with income eligibility limits for higher earners. You can rollover Roth 401(k) accounts, as well as convert traditional IRAs and 401(k) accounts, to a Roth IRA. Because of their tax-preferred status, they can also work well for strategies with higher levels of turnover and investments with a higher tax impact [e.g., real estate investment trusts (REITs), corporate bonds, etc.].

Inherited IRAs and Inherited Roth IRAs—These differ from their similarly named counterparts in several ways. Mandatory withdrawals generally exist for both (though a spouse can make such accounts their own traditional or Roth IRA). They also do not receive bankruptcy protection in most states. Investment transactions within such accounts are not taxable, though withdrawals may be.

Workplace Retirement Accounts—The most common type is the 401(k) plan. These accounts are funded with pretax dollars with much higher contribution limits than IRAs ($19,500; $26,000 if age 50 or older). Roth 401(k) plans have similar contribution limits but are funded with aftertax dollars. RMDs exist for both (which is why it can make sense to roll over a Roth 401(k) to a Roth IRA when retiring or changing jobs). Investments are generally limited to the plan’s menu unless there is a brokerage window. Costs are generally higher than an IRA or a traditional IRA, though it varies. They are tax-preferred, which makes them suitable for holding funds with higher tax-cost ratios (though such funds’ expense ratios and performance should be examined). A big advantage of these plans is that contributions come directly out of your salary, which automates the savings process.

Pensions are offered by some employers (though much less so than in years past). They provide a stream of cash flow that can allow for more aggressive allocation to stocks in other accounts. Annuities may also be offered; such offerings should be scrutinized against other plan offerings—particularly based on costs and redemption fees.

Insurance Products—Whole and universal life insurance policies are used by some as investment accounts. The investment options available vary and come with higher expenses than when a brokerage or mutual fund account is used instead. Complexity is also higher. These policies work best for those who need them for estate-planning purposes.

Annuities provide a source of ongoing cash flow. Economists like them because they transfer longevity risk (the risk of living longer than expected) from the person to the insurance company. There are constraints on withdrawals and unless a rider is purchased the contract terminates at death. The costs can be high.

There is obviously more to this discussion, and we’ll address some of those topics in future AAII Investor Updates. For now, I would encourage you to try out our financial account inventory worksheet. It’s a prototype (and we realize there are fields we could add if it was web-based—which is part of the longer-term plan), but even in its current form, it’s the type of document you should have if you haven’t already created one yourself.