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Financial Investment Accounts

Published: April 2nd, 2023 by Chris McGrath
Last Updated: Nov 6th, 2023

Note: For the sake of simplicity, I'm only covering concepts and accounts relevant to the "Financial Investment Advice" page, rather than a comprehensive list of all possible investment options.

Retirement Accounts

The following are types of retirement focused investment accounts. They're known as retirement accounts because the IRS uses fees to discourage certain types of withdrawals until age restrictions are met. Restrictions on 401k and IRAs are removed at age 59½. HSAs remove a restriction at age 65.

Taxed Now

Roth IRA

What is a Roth IRA?
A Roth IRA is a type of Individual Retirement Account, where you pay taxes now, and avoid taxes later.

Why is a Roth IRA categorized as taxed now?
It's funded from your checking account. (So it's funded by income you've already paid taxes on.)

Why are Roth IRAs considered as "tax advantaged" retirement accounts?
Once you reach retirement age, 59½, you don't pay any taxes on withdrawals. (In other words, the compound interest can be withdrawn tax-free.)

Notes of Interest about Roth IRAs:

  • You can withdraw your original contribution both tax and penalty free at any time for any reason. (You only have to worry about the 59½ retirement age restriction to avoid penalties for withdrawing profits associated with compound interest.)
  • Roth IRA & Traditional IRAs have a shared yearly contribution limit of $6.5-15k.
    • Shared, as in every dollar you invest in one is a dollar you can't invest in the other.
    • If you max out your Roth IRA, you can't contribute to a Traditional IRA that year, and vice versa.
    • Where $6.5-15k comes from:
      • For 2023, individuals can contribute a max of $6.5k/year. (Individuals age 50++ can add $1k/year.)
      • Married couples count as 2 individuals, after you max out your IRA, you can max out your spouse's IRA even if they're unemployed. (401k's don't have this option, unless you're both employed.)

Taxed Later


What is a 401k
A 401k is a retirement account offered by employers.

Why is a 401k categorized as taxed later?
401k accounts are funded directly from your paycheck using pre-tax dollars. When you hit retirement age and start withdrawing from the account both, the compound interest and original contribution are treated as income. This has a net effect of differing income tax to be paid at a future date. ("taxed later")

Notes of interest about 401k accounts:

  • A common employee benefit to attract and retain talent is to offer cash matching on employee contributions up to a limit. (Examples: 100% match of 3.5% of income or 100% match up to 3k/year)
  • If you sign up for a 401k and don't pick your investment options, you'll be thrown into some kind of default investment option. You should always review the defaults. (So far, every time I've reviewed the default investment options for myself and family members, I've always found the default option to be suboptimal.)
  • Individuals can contribute a max of 22.5k/year, workers 50++ can add 7.5k/year more. (per 2023 rules)
  • If a married couple are both employed, each person could max out their own 401k, effectively doubling the limit. For a single income household, the individual limit would be the max.
  • 401k investment choices tend to be extremely limited.
    As a point of reference, my current 401k plan lets me pick between 24 investment choices. (All of my previous employer's plans also lacked many options.)

Rollover IRA

What is a Rollover IRA?
It's an account you can create to consolidate multiple 401k accounts into or give you more investment options if you don't like those offered by your current 401k. Rollover IRAs are created/funded by rolling over (converting) a 401k account into a Rollover IRA.

There are 2 reasons why Rollover IRAs exist:

  1. Consolidation:
    Each job you work at can result in a 401k account. So 5 jobs could result in 5 401k accounts. A rollover allows you to consolidate multiple 401k accounts into a single account without triggering a withdrawal (taxable event). You can rollover a 401k from an old employer into either the new employer's 401k plan or a Rollover IRA.
  2. Freedom of Choice:
    So why might you choose to consolidate into a Rollover IRA, instead of consolidating into your new employer's 401k? Your employer picks the options that are available in your 401k. If you don't like the options available, then you can transfer the funds to a Rollover IRA, which means you have greater choice of investment options.
    Here's some perspective on what freedom of choice means:
    • My current 401k plan has 24 investment options.
    • Number of investment options with a Fidelity Rollover IRA?
      "It's Over 9000!"

Why is a Rollover IRA categorized as taxed later?
Since it was converted from a 401k, which was funded using pre-tax dollars, the same taxed later logic applies: Post retirement withdrawals are treated as taxable income.

Traditional IRA

What is a Traditional IRA?
A Traditional IRA is a type of Individual Retirement Account, where you differ paying taxes now* and pay them later instead.

Why is a Traditional IRA categorized as taxed later?
Let's say, after months of earning income and getting taxed on it, you end up with $6.5k in your checking account. If you contribute the $6.5k to a Traditional IRA, then at tax time your taxable income would be lowered by the amount of your contribution. This would result in a tax refund, which would have a net effect of making $6.5k of your income tax differed. The tax refund makes it as if you hadn't paid taxes in the present. Then at retirement age when you withdraw funds (both the original contribution and compound interest) from the account, the withdrawals will be treated as taxable income.

Health Savings Account

What is a HSA?

  • HSAs are a tax advantaged account, that offers a discount on medical bills and can double as a retirement investment account.
  • HSAs allow you to pay for health care costs using pre-tax dollars. So instead of earning $4k, losing ~25% to taxes, having $3k after taxes, and getting hit with a $3k medical bill. You can put $4k into an HSA, not pay any taxes on it. Pay for the $3k medical bill using the HSA and still have $1k in the HSA. (HSA equals free money.)
  • As long as you use it for medical expenses, you can use the original contribution AND compound interest tax-free without having to wait until retirement age.

Why is a HSA categorized as a taxed later retirement account?

  • HSAs are funded by Pre-Tax Dollars.
  • If you have over $1k in your HSA, anything extra can be invested in stock market index funds. So, if you have $10k. You can keep $1k available to pay medical bills and invest the other $9k.
  • If you max out your HSA, and the compound interest grows well past the point of what you'd ever need to pay medical bills, then it's no problem. Once you turn 65, you'll be able to withdraw excess funds from it, much like a 401k. (Non-medical related withdrawals will be treated as tax differed income. The medical related withdrawals will still be tax-free.)
  • Although, the option of treating excess HSA funds like 401k funds exists. It may be worth allowing the excess funds to grow into a surplus, so you won't need to worry about assisted living expenses when you're older.

Notes of interest about HSAs:

  • If you or your spouse has a High Deductible Health Plan (HDHP). Then individuals can contribute up to $3850 and families can contribute up to $7750 per year (per 2023 rules).
  • Note that the HDHP requirement is only for opening / contributing to an HSA. If you max it out for 5-10 years when you're young and in good health. Then it could earn enough compound interest to sustain itself indefinitely. That means you could switch to a non-HDHP plan in the future if you want, but still be able to pay medical bills using your now self-sustaining HSA.
  • Technically, there are 2 types of HSAs: Employer Provided and Third Party Provided.

Employer HSA

Employer Provided HSAs are funded similarly to 401k's:
  • You can fund them with pre-tax dollars deducted from your paycheck.
  • Like 401k's they tend to have limited investment choices. As a point of reference, my current employer provided HSA plan lets me pick between 32 investment choices.

Third Party HSA

Third Party Provided HSAs can be thought of as the HSA equivalent of a Rollover IRA. (They can also work similar to a Traditional IRA, but there's less of a tax advantage if you go that route.)

  • If you find your employer provided HSA to be lacking: You have the option of signing up for an HDHP, but instead of opening and contributing to an employer provided HSA, you can open up an HSA through a third party and fund it from your checking account.
  • Third Party Provided HSAs aren't the best idea for initial contributions to an HSA for 2 reasons. First contributing from your checking account means the pre-tax advantage would come in the form of a tax refund, that implies missing out on time to grow in the stock market. Second, you'll only get a partial tax refund, because if you go this route you'll be required to pay FICA taxes (if the original contributions go through a Third Party HSA). In other words, an original contribution to a Third Party HSA isn't as tax-advantaged as an original contribution to an Employer Provided HSAs. Interestingly, Third Party HSAs are as tax-advantaged as Employer Provided HSAs when doing a rollover (consolidation / transfer) into a Third Party HSA.
  • Third Party Provided HSAs make the most sense when you treat them similar to a Rollover IRA. Let's say you have an HSA with Employer A then switch jobs to Employer B. You'll gain the best tax advantage for new contributions by using Employer B's provided HSA; However, when it comes to your old HSA established through Employer A, you now have a choice of rolling it over into Employer B's HSA or rolling it over into a Third Party Provided HSA. In this case, it makes more sense to roll over the existing account into a Third Party Provided HSA, as it's possible to find one with more investment options and cheaper fees. Also, you'll have already received the tax benefits since the initial contributions were done through Employer A.
  • Note: Fidelity offers Third Party HSAs.

Investment Account

Taxed Now and Later

Brokerage Account

What is a Brokerage Account?
A brokerage account is just a normal investment account. It often has the same and more investment options than a retirement focused investment account.

How do taxes work on a Brokerage Account?

  • You'd fund it from your checking account (where you've already paid income tax / been taxed now).
  • You pay taxed on profits generated by dividends (company earnings shared with stockholders) and capital gains (profits from selling for more than you purchased for.)
    You'll be taxed each year you earn dividends: taxed now
    You'll be taxed when you decide to sell your stock for cash: taxed later
  • Unlike tax later retirement accounts where income tax is applied to the profits, with a brokerage account the profits are taxed according to capital gains and dividends tax rules. (which can be significantly lower than income tax, sometimes even 0%.)