In investing in mutual funds, there are many types of accounts through which you can invest. The typical type of accounts that are used by investors include:
When buying mutual funds, you can always purchase a mutual fund directly from the mutual fund company through a mutual fund account. Typically, any one mutual fund account is designated for only one mutual fund. Therefore, if you want to purchase four mutual funds, you will need to open four mutual fund accounts. The drawback to using a mutual fund account is the inability to easily trade mutual funds between mutual funds – this becomes particularly problematic when trading funds between multiple fund companies.
Brokerage houses offer clients a number of different accounts. The most common ones are a cash account, a margin account (frequently called a "cash and margin" account), and an option account (frequently called a "cash, margin, and option" account). Basically, these accounts represent different levels of credit and trustworthiness of the account holder as evaluated by the brokerage house.
A cash account is the traditional brokerage account (sometimes called a "Type 1" account). If you have a cash account, you may make trades, but you have to pay in full for all purchases by the settlement date. In other words, you must add cash to pay for purchases if the account does not have sufficient cash already. In sleepier, less-connected times than the year 2002, most brokerage houses would accept an order to buy stock in a cash account, and after executing that order, they would allow you to bring the money to settle the trade a few days later. In the age of internet trading, however, most brokers require good funds in the account before they will accept an order to buy. Just about anyone can open a cash account, although some brokerage houses may require a significant deposit (as much as $10,000) before they open the account.
Typically, depending on your account balance, brokerage firms offer a different level of service. These break-points differ from brokerage company to brokerage company. But they typically occur at $50,000, $250,000, $500,000 and $1 million.
Some of the features offered by the major brokerages include:
In addition to mutual fund, brokerage, and margin accounts, most investors will have at least part of their portfolio in a retirement account. There are many types of retirement accounts. Below, we will be briefly discussing the following retirement accounts:
In the following sections, we provide a brief description of the typical various retirement account options. This is by no means a complete discussion, but is meant to give you a sense of the potential benefits of retirement accounts and how they fit into your overall portfolio.
There is no question that the world of retirement and retirement plans is a confusing one. With so many varieties and flavors how does an individual know which one is best for his or her situation? This tutorial looks at the Traditional Individual Retirement Account--otherwise known as the Traditional IRA. We will go through how it works, how to set one up, and even how to withdraw from it.
A Traditional IRA is an excellent supplement to an individual’s retirement income. Making contributions is flexible, so individuals can choose when they want to fund the Traditional IRA. Also, contributions to a Traditional IRA may be tax deductible, and the earnings grow on a tax-deferred basis. Assets in the Traditional IRA are not taxed until they are withdrawn. This means that the owner can defer paying taxes until retirement, when he or she is most likely in a lower tax bracket. On an amount received during retirement, the owner of the Traditional IRA may pay less tax than on an amount received during pre-retirement years.
One benefit of investing in an IRA is that the investment options are many and varied. There are relatively few investments that are not permitted in an IRA. The ability of the IRA owner to choose the type of investment depends on the IRA product and the financial institution. Some IRAs may be limited to a pre-selected core group of investments or a specific investment while, for other IRAs, the IRA owner is free to choose the investments. These are commonly referred to as self-directed IRAs (SDAs).
Permissible investments for IRAs include stocks, bonds, mutual funds, real estate, some coins, and money market funds.
A Traditional IRA can be funded by several sources:
Since IRA funding limits change regularly, for details on the funding limits and any other restrictions, please see http://www.irs.gov, of your brokerage account documentation.
The Roth IRA is arguably the IRA with the most potential. There are many similarities between the Roth and Traditional IRA but also some striking differences. Here we look at the Roth Individual Retirement Account, how it works, how to set one up, and even how to withdraw from it.
Like the Traditional IRA, a Roth IRA is an excellent supplement to an individual's retirement income, but unlike the Traditional IRA, for which earnings accrue on a tax-deferred basis, the Roth IRA accrues earnings on a tax-free basis. For Roth IRAs, qualified distributions are tax-free and contributions are never tax deductible. Similar to the contributions to the Traditional IRA, making contributions to the Roth IRA are flexible, so individuals can choose when they want to fund the Roth IRA.
A Roth IRA must be established with an institution that has received IRS approval to offer IRAs. These include banks, brokerage companies, federally-insured credit unions, and saving & loan associations.
A Roth IRA can be established at anytime. However, contributions for a tax year must be made by the IRA owner's tax-filing deadline, which is generally April 15th of the following year. Tax filing extensions do not apply.
There are two basic documents that must be provided to the IRA owner when an IRA is established:
Individuals whose modified AGI falls within a certain range may not be able to contribute up to the full contribution limit. These individuals must use a formula to determine the maximum amount they may contribute to a Roth IRA.
Since the contribution limits change regularly, for detailed contribution limits, please see http://www.irs.gov or your brokerage account for details.
A Roth IRA can be funded from several sources:
A SEP is a retirement plan established by employers, including self-employed individuals (sole proprietorships or partnerships). The SEP is an IRA-based plan to which employers may make tax-deductible contributions on behalf of eligible employees. The employer is allowed a tax deduction for plan contributions, which are made to each eligible employees' SEP IRA on a discretionary basis
Employees do not pay taxes on SEP contributions, but these contributions are taxed when the employee receives a distribution from the SEP IRA.
An employee (including the business owner) who is eligible to participate in his/her employer's SEP plan must establish a Traditional IRA to which the employer will deposit SEP contributions. Some financial institutions require the Traditional IRA to be labeled as a SEP IRA before they will allow the account to receive SEP contributions. Others will allow SEP contributions to be deposited to a Traditional IRA regardless of whether or not the IRA is labeled as a SEP IRA. Because the funding vehicle for a SEP plan is a Traditional IRA, SEP contributions, once deposited, become Traditional IRA assets and are subject to many of the Traditional IRA rules, including the following:
A retirement plan that may be established by employers, including self-employed individuals (sole proprietorships and partnerships), a SIMPLE IRA allows eligible employees to set aside part of their pre-tax compensation as a contribution to the plan and defer the tax on the money until it is distributed to them. This contribution is called an elective deferral or salary reduction contribution.
Employers are required to make either matching contributions, which are based only on elective deferral contributions made by employees, or non-elective contributions, which are paid to each eligible employee regardless of whether or not the employee made salary reduction contributions to the plan. For a matching contribution, the employer's contribution may match the employees elective deferral contribution up to a certain dollar amount or a percentage of compensation.
Like other employer plans, the SIMPLE IRA allows employers a tax-deduction for contributions they make to the SIMPLE IRA plan.
The employee's contributions to the SIMPLE IRA are not taxed, but distributions from the SIMPLE IRA are.
Unlike qualified plans, a SIMPLE IRA plan is easy to administer. The start-up and maintenance costs for SIMPLE IRAs are very low compared to qualified plans. Because the responsibility of funding the SIMPLE IRA is shared between the employer and employee, employees have some degree of control over how much and when (the years) their SIMPLE IRAs may be funded.
The investment options for a SIMPLE IRA are many and varied, and there are relatively few investments that are not permitted for a SIMPLE IRA. The investment choices of the SIMPLE IRA owner depend on the SIMPLE IRA product and the financial institution. Some choices may be limited to a pre-selected core group of investments or a specific investment. With SIMPLE IRAs that are commonly referred to as self-directed SIMPLE IRAs, the owner is free to choose the investments.