Where Your Money Goes (Part 3)
Investing
In Part 2, we looked at savings options designed to protect money you may need soon.
Once funds no longer need to be immediately available — and can tolerate some ups and downs — a different category of accounts comes into play. These are designed for long-term growth.
Employer-Sponsored Retirement Accounts
What they are
Investment accounts offered through work
Often named after the section of the tax code that governs them:
For-profit companies: 401(k)
Schools, hospitals, and non-profits: 403(b)
State and local governments: 457(b) or 401(a)
Federal government and military: Thrift Savings Plan (TSP)
Benefits
Favorable tax treatment
Often include an employer match
The employer adds money alongside what you contribute
A $1-for-$1 match effectively doubles the amount invested
Because it’s so valuable, try to capture your employer’s full match
Automatic payroll deductions make saving regular and low-friction
Limitations
Limited investment choices
Restrictions on when money can be accessed; intended to be accessed at or near retirement age
Individual Retirement Accounts (IRAs)
What they are
Investment accounts you open on your own
Widely available at many large investment firms such as Vanguard, Fidelity, and Charles Schwab
Two main types:
Traditional IRAs — taxes are paid later, when money is taken out
Roth IRAs — taxes are paid up front, before money is invested
Benefits
Favorable tax treatment
More control over investment choices: access to a wide range of investments, including mutual funds, index funds, ETFs, stocks and bonds
Limitations
No employer match
Lower annual contribution limits than many workplace plans
Restrictions on when money can be accessed
Contribution eligibility can phase out at higher income levels
Taxable Brokerage Accounts
What they are
Standard investment accounts with no special tax advantages when money is deposited or withdrawn
Benefits
Maximum flexibility
No limits on how much you can invest
No restrictions on access to money
Very broad investment choices
Limitations
No tax deferral or sheltering
Investment income (ie. interest, dividends, and capital gains) is generally taxed each year
We’ll cover the tax treatment of dividends and long-term capital gains in a future post. While these accounts don’t receive the same tax advantages as retirement accounts, the tax rules are often more favorable than many people expect.
Over this series, we’ve looked at the main places money typically goes: checking for spending, savings for near-term needs, and investing for long-term growth.
The key isn’t choosing one account type over another, but understanding the role each one plays — and using the right tool for the right job.
In some cases, the tax treatment of these accounts creates outsized advantages — particularly for young earners. We’ll explore one of the most powerful examples next.