Types of Accounts:
The alphabet soup of places You can save your hard-earned money
When it comes to saving your money, one of the questions people often ask is where is the best spot to put it? While there is a lot of nuance behind that question and providing an answer, let’s explore some of the places we can stash some cash
As you can see, we have a long list of options available to us, each with their own pros and cons…and some that are mostly cons, in our opinion.
The Classic: Savings Account
Ah, the good old savings account. It’s like the vanilla ice cream of the financial world—reliable, predictable, and a little bit boring. But hey, it gets the job done. You put your money in, and it earns a bit of interest. Just don’t expect it to make you rich overnight; and don’t be surprised when you learn that it is likely losing purchasing power every year to taxes and inflation. This is a decent option for that vacation fund or rainy-day fund.
The Overachiever: High-Yield Savings Account
If a regular savings account is vanilla, then a high-yield savings account is like vanilla smothered in caramel sauce. These accounts offer higher interest rates, which means your money grows faster. But remember, with great power comes great responsibility—or at least, a higher minimum balance requirement in some cases. Good uses include: rainy day fund, emergency fund (yes, there is a difference), downpayment fund.
The Commitment-Phobe: Money Market Account
Money market accounts are like the dating app of savings options. They offer higher interest rates than regular savings accounts and can come with check-writing privileges. But beware, they often require a higher minimum balance and take time to transfer to a saving or checking account. Swipe right if you’re looking for flexibility and a bit more interest. Good uses: a slightly less liquid alternative to the HYSA above.
The Planner: Certificate of Deposit (CD)
CDs are for those who like to plan ahead. You lock your money away for a set period, and in return, you get a guaranteed interest rate. It’s like putting your money in a time capsule, except when you dig it up, it’s worth more. Just don’t break the seal early, or you’ll face a penalty. Unless you have a time-specific goal for these dollars, you can probably achieve better results with an alternative. Ex: You are purchasing a car in 6 months and buy a 6-month CD.
The Retirement Trio: Traditional IRA, Roth IRA, and 401(k)
TraditionalIRA
A Traditional IRA is a retirement savings account that offers tax-deferred growth. Contributions may be tax-deductible, which can lower your taxable income for the year. However, you’ll pay taxes on withdrawals in retirement. It’s a great option if you expect to be in a lower tax bracket when you retire. There are annual limits on how much you can contribute, and income limitations that determine whether your contribution can be tax-deductible.
Roth IRA
A Roth IRA is funded with after-tax dollars, meaning you don’t get a tax break on contributions. However, your money grows tax-free, and qualified withdrawals in retirement are also tax-free. This is ideal if you expect to be in a higher tax bracket in retirement (does anyone really think their taxes are going down?). This account also has contribution and income limits, but there are some clever workarounds thanks to open, and completely legal, IRS loopholes.
401(k)
A 401(k) is an employer-sponsored retirement plan. Contributions are made with pre-tax dollars, reducing your taxable income. Many employers offer matching contributions, which is essentially free money for your retirement. Withdrawals in retirement are taxed as ordinary income. This is often most people’s largest retirement asset, good or bad. The key point here is that every dollar you withdraw will one day be taxed at a rate over which you have no control. Not ideal, given Uncle Sam’s penchant for changing the rules on us.
(also included here are 401(a)s and 403(b)s, which are essentially the same as the better-known 401(k), but created for specific industries)
*401(k)s now largely also include a Roth contribution option. These dollars follow the same rules are Roth IRAs, but without contribution and income limits. Employer contributions are still pre-tax, essentially giving you 2 different accounts: Roth and pre-tax 401(k)s.
Retirement Trio’s Lesser-Known Sidekick: The Thrift Savings Plan
The TSP, as it is widely known, is like the 401(k) plan for federal employees and military members. Same rules apply, but the investment options available are incredibly limited. Roth TSP option is available as well.
The Education Duo: 529 Plan and Coverdell ESA
529Plan
A 529 Plan is a tax-advantaged savings plan designed for education expenses. Contributions grow tax-free, and withdrawals for qualified education expenses are also tax-free. It’s a fantastic way to save for your child’s college tuition and other educational costs. Check out our separate blog post on this topic for more information.
Coverdell Education Savings Account (ESA)
Similar to a 529 Plan, a Coverdell ESA offers tax-free growth and tax-free withdrawals for qualified education expenses. However, it has lower contribution limits and can be used for K-12 expenses as well as college costs. (see above about the previous blog post).
The Extreme Tax Avoider: Health Savings Account (HSA)
The HSA represents the ultimate in tax avoidance, not evasion. Let’s not get the wrong idea. This account is the only legal vehicle that has triple-tax avoidance. No tax going in, no tax on growth, no tax coming out (assuming it is for qualified medical expenses). What’s not to love here? Contribution limits apply and you must be enrolled in a high-deductible health insurance plan to have access.
The Small Business Saver: SEP, SIMPLE, and Solo
SEP IRA and Roth Version
A Simplified Employee Pension (SEP) IRA is a retirement plan that allows small business owners to make tax-deductible contributions for themselves and their employees. Contributions grow tax-deferred, and withdrawals in retirement are taxed as ordinary income. Best for sole proprietors with no other employees. Calculations for how much you can contribute apply, and contributions must be made to all employees.
SIMPLE IRA and Roth Version
A Savings Incentive Match Plan for Employees (SIMPLE) IRA is another option for small businesses. It allows both employer and employee contributions, with tax-deferred growth and taxable withdrawals in retirement. It’s simpler to set up and administer than a 401(k), and is often a cheaper option. Here you have options for contributions to employee accounts, but lower overall contributions as the owner than some of the alternatives.
The Self-Employed Solution: Solo 401(k) and Roth Solo 401(k)
A Solo 401(k) is designed for self-employed individuals and offers the same benefits as a traditional 401(k), including tax-deferred growth and employer matching (in this case, you are both the employer and employee). It also allows for higher contribution limits compared to other retirement accounts.
The Top Hat: 457(f)
The 457(f), not to be confused with the 457(b), is typically offered to highly compensated employees or key executives, mostly in tax-exempt organizations, like hospitals, and government entities. It’s called a ‘top hat’ plan because it is in addition to other plan options available, like a 401(k) or 403(b). The best part, contributions are made by the employer. Rules around vesting and taxation are different than other qualified plans.
The Insurance Options
Annuities
This option, like its counterpart below, could, and probably will at some point, take up an entire blog post by itself, but for now, we will cover the basics. An annuity is an insurance contract designed to pay an agreed-upon income stream at some point in the future (or immediately in the case of immediate income annuities). To fund them, you most often make lump sum contributions, but you can make a series of contributions over a period as well. There are countless riders and options available to enhance the growth or the guarantees of these contracts, but they come with costs. Be aware of surrender charges and other high costs associated with some annuities.
Life Insurance
Some life insurance contracts are designed to accumulate assets over time. These are called permanent life insurance policies, and Dave Ramsey hates them. Like annuities, there exist a huge, and ever-changing, number of options for these contracts, but the basics remain the same. You make contributions (mostly fixed, but other options can exist) to the policy for a period of time. The cash value inside the policy grows without any taxation. It can then be withdrawn tax-free (surrender of basis, then policy loans – complicated subject alert!!!) for use.
The Super-Saver: Cash Balance Plan
For those (mostly business owners) with a cash balance pension plan, the savings can really be super-charged. This is a type of defined benefit retirement plan that combines features of both traditional pension plans and defined contribution plans, like 401(k)s…except the contribution limits are significantly higher. Up to $270,000 for 2024.
Final Word
As you can see, the options are seemingly endless. Whether you’re a fan of vanilla or like the more exotic selections, there’s an account out there for you. And remember, at Cadence Wealth Partners, we’re here to make financial planning a little less complex and a lot more fun—one savings account at a time.
Disclaimer: This blog post is for informational purposes only and does not constitute financial advice. Please consult with a financial advisor to determine the best strategy for your individual needs.
