Investing is the act of committing money or capital to an endeavor (a business, project, real estate, etc.), with the expectation of obtaining an additional income or profit. Investing can be in the form of earned capital or in the form of time and labor. Many young people invest a lot of time going to college and put of working in hopes of earning a much larger salary down the road. Most of us invest our time in someone else’s investment in hopes that they will pay us. Investing capital/money is only possible once you have created a surplus of capital above and beyond your monthly or yearly living cost, I guess you could borrow to invest but I don’t recommend that. So the first thing you need to do is create a monthly list of all expenses you current have and then tally up how much income you bring home in a month. If you have more income than expenses then you can start investing. Now before we get to far along and get all excited about earning profits, let me say that I believe that it is best to first pay off debt because it gives you a guaranteed return because it keeps you you from owing others interest and it will eventually free up a lot more monthly income for investing. The one exception I will always make is that if your company offers a 401K match then you should always, always, always invest enough to get the full match, this is like free money (FREE $$$$). Below are some of the most popular investment vehicles, when I say vehicle I mean a place to park investments. 401Ks, IRAs, ROTH IRAs, or individual accounts are not investments in of themselves but accounts that you can buy stocks, bonds, mutual funds, etc… in and hold them there.
401K – The most common employer sponsored plan. Contributions go in pre-tax and grow tax free until they are withdrawn. In general 401K owners can tap into their savings at age 59 and a half, any time before then and you could be subject to a 10% early withdrawal fee in addition to the taxes being due. Additionally at age 70 and a half you will be forced to take minimum distributions/withdrawals from the account. The minimum withdrawals will be based off account balance and your expected life span. The withdrawals will be taxed at your current income tax rate. The term 401K actually refers to the tax code that was enacted in 1978 to allow for pre-tax contributions. A major advantage of most 401K plans is that the employer who is sponsoring the plan usually offers a match on the employees contribution up to a certain predetermined amount. The current limit on annual contributions is $18,500.
IRA – An IRA stands for Individual Retirement Account and operates much like a 401K but isn’t run by an employer, this usually allows for a much more divers array of investment options. One major difference is instead contributions going in pre-tax is that your contributions are credited back to you as a tax write off, thus lowering your taxable income. The rules are basically the same as the 401K plan in that you must be 59.5 to make a withdrawal without being penalized and will be required to take minimum withdrawals at 70.5 years of age. The current limit on annual contributions is $5,500.
Roth IRA – The Roth IRA was established by the Tax payer relief act (Public Law 105-34) and named for its chief legislative sponsor, Senator William ROTH of Delaware. A ROTH IRA is similar to an IRA in that it is privately owned and operated by an individual, with a lots of investment options. Unlike a IRA, ROTH contributions go in after tax but are allowed to grow tax free and not taxed when withdrawn. Another huge advantage is that there is no age for required withdrawals and you contributions can be withdrawn anytime penalty free, however your account earnings will be subject to a penalty if withdrawn before age 59.5. There are limits on who can contribute, single earners over $120,000 and married over $189,000 can no longer contribute to a ROTH IRA. The current annual contribution limit is $5,500.
403b – A 403(b) plan, also known as a tax-sheltered annuity (TSA) plan, is a retirement plan for certain employees of public schools, employees of certain tax-exempt organizations, and certain ministers.
Individual accounts in a 403(b) plan can be any of the following types.
- An annuity contract, which is a contract provided through an insurance company.
- A custodial account, which is an account invested in mutual funds.
- A retirement income account set up for church employees. Generally, retirement income accounts can invest in either annuities or mutual funds.
A 403b plan can be set up for contributions to be pre or post tax, depending on the administrator of the account.
SEP 401k/SEP IRA – These plans are for individuals that are self employed or own a small business. They operate just like regular 401k and IRA accounts except that the business owner is the administrator and in the SEP 401k plan can make contributions as the employee and as the owner.
Taxable Account – A taxable account is a regular account that offers no pre or post tax savings or deferrals.