Are You Investing In The Right Account For Your Goal?

March 12, 2019

When it comes to investing, we talk a lot about “asset allocation” but what about “asset location?” Are you investing in the right account(s) for your goal(s)? Let’s take a look at some common financial goals and which account(s) might be best for them:

Emergency fund

The key here is easy access to your money in case of an emergency. Most tax-advantaged accounts have restrictions and penalties for most withdrawals, but the Roth IRA is an exception. You can withdraw the sum of your contributions at any time and for any purpose without tax or penalty. If you withdraw earnings before 5 years and age 59 ½, you’ll probably have to pay taxes and a 10% penalty on those withdrawals, but the contributions always come out first.

Buying a home

A traditional or Roth IRA can be a good choice here since you can withdraw up to $10k penalty-free (and tax-free from a Roth IRA after 5 years) for a home purchase if you and your spouse haven’t owned one in the last couple of years. (Since Roth IRA contributions can always be withdrawn tax and penalty-free, the $10k limit can be applied just to the earnings.)

You may also be able to borrow from your employer’s retirement plan to purchase a home and have a longer time period to pay it back than with a regular retirement plan loan.

Retirement

If your employer offers a match, start there so you don’t miss out on the free money. Once you’ve maxed the match, you can also contribute to an IRA if you prefer having more flexibility than what your employer’s plan offers. An HSA can also be part of your retirement savings since the money can be used penalty-free for any purpose at age 65 (and will still be tax-free for qualified medical expenses including some Medicare and long term care insurance premiums).

Education

The most popular option is a 529 plan, which allows the earnings to be withdrawn tax-free for qualified education expenses. The plans are run by the states and each has different investment options. You’re not required to contribute to the plan for the state you live in or where you child goes to school, but some states offer special state income tax breaks for contributions to your own state’s plan.

If you prefer more flexibility, you can also contribute to a Coverdell Education Savings Account, which has similar federal tax benefits, but contributions are limited to $2k per year and the money has to be used by the time the beneficiary turns 30. Finally, you can withdraw money from an IRA penalty-free for education expenses, but make sure you’re not jeopardizing your retirement.

Of course, if you max out the contribution limits of any of these accounts or just don’t want to tie up your money, you can always contribute to a regular taxable account too. If you’re still not sure which account(s) makes sense for you, consult with a qualified and unbiased financial planner. Just don’t let indecision about which account to save in prevent you from saving at all!