| Understanding Investment Accounts |
| by Kent E. Irwin |
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| Now that you you have read the previous article and understand how to invest your money, the next question you face is choosing between tax-advantaged and non-qualified accounts. This article will help you understand the difference between them, what they are intended for, and how to prioritize your investment decisions. This is the second in a series of three articles on Investment Management; please read all three articles: Fundamentals of Investing, Understanding Investment Accounts, and Investing – Do it Yourself? |
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| Prioritizing Your Investments |
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| Many people are confused by all of the different investment ‘buckets’ like IRAs, 401(k)s, 529s, and non-qualified accounts. The confusion is best cleared up by obtaining a financial plan. Your eFinplan financial plan will help you plan for your future goals. Once you know what your future goals are, then you can begin to choose what investment ‘buckets' are best for you. Before we discuss prioritization in more detail, let’s discuss asset classes and asset ‘buckets’ to help clear up the differences. |
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| Asset Classes |
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| As a review from the first article, “Investment Management: Part 1,” an asset classification (table 1) indicates the investments that you place your money into, so that they will appreciate. A ‘bucket’’ (table 2) is the holding label of your investment. The ‘bucket’’ label is important, because it may provide certain ownership or tax status; therefore, it is important for you to understand the difference. |
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| Table 1 | Asset Classifications | Asset Category | Sub Set |
| Asset Category | Sub Set | Cash Equivalents | Savings Accounts | Stock | Domestic | Certificates of Deposit (CD) | Foreign | Money Market Accounts | Small Cap | Bond | Short Term | Mid Cap | Intermediate Term | Large Cap | Long Term | Specific Sector (e.g., Utilities) | High Yield | Tangibles | e.g., Precious Metals |
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| Asset ‘Buckets’ |
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| Asset ‘buckets' are the way your assets are titled or held. Just about any asset listed above can be invested and put into one of these asset ‘buckets’; |
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| Table 2 | Asset ‘Buckets’ | Tax Advantages? | Asset ‘Bucket’ Name | Asset Sub‑Category | Example | Main Purpose | Secondary Purpose | Yes | Qualified | Pension Plan | 401(k), Profit Sharing, Keogh, SEP | Retirement
| Loan option on pension plan for college | IRA | IRA, Roth IRA, | Payroll Deduction (available for not-for-profit institutions) | 403(b), 457(b) | 529 | Pre-paid tuition and College Savings Plans | Direct- and advisor-sold plans | College Education
| There may be other options if not used for college | Minors Act | Uniform Gift to Minors (UGMA) or Unified Transfer to Minors Act (UTMA) | UGMA or UTMA | College Education | Down payment on a business or home | No | Non-Qualified | Regular Savings | Individual or joint or trust-owned savings account | Emergencies and short-term needs | All Purposes | Investment Account | Individual, joint or trust-owned investment account | All Purposes | All Purposes | Tax status, investment options, ownership issues, and limitations vary. Please consult your tax or investment advisor for full information. |
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| Looking at this table, you can see that there a basically two types of investment brackets: tax and non-tax advantaged. Within each bracket, there are several ‘buckets'. For all accounts, the taxation varies greatly depending on many factors. |
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| Prioritizing Investments into Asset ‘Buckets’ |
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| Identifying what bucket to invest in first, second, and so on depends on various factors, the overriding ones of which are those based on your financial plan. If you have an eFinplan financial plan, you will know which areas that additional funding is needed, and you can allocate your investment ‘buckets’ accordingly. |
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| Table 3 | Typical Priorities | Priority Rank | Priority Item | Reason | 1 | Emergency Cash Reserves | Assets need to be liquid, easily accessible without risk that value may go down. Reserves allow for emergencies and unexpected expenses without jeopardizing cash flow, increasing risks, and taking money from accounts that are being set aside for the other 4 priorities. In addition, if you needed to pull money out of retirement plans, there could be adverse tax ramifications. | 2 | Saving for specific goals, such as a new car or the down payment on a home | There are many things that require fairly large sums of money all at once, such as buying a new car or taking a vacation. In order to ensure that you have the money you need when you need it—without borrowing it or affecting other goals, it is important to save money regularly toward these planned expenses. | 3 | Retirement/Financial Independence | May be forced upon us by economic factors, corporation re-organization, or health constraints. Most financial advisors recommend that you fully maximize the amount you are able to put into pension plans and IRAs prior to investing in other ‘buckets’. These retirement plans usually provide very good income tax advantages. | 4 | College Education | Most financial advisors recommend that college education savings priorities should fall behind retirement goals. | 5 | Vacation Home | Items like this are usually the lowest priority and should not be purchased until other ‘buckets' have been fully funded. |
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| Prioritizing Investments into Asset ‘Buckets’ |
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| As you progress on the road to achieving your financial plan, you will progress up the financial planning and investment staircase.
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| 5 |
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| 4 | Vacation Home | Non-qualified |
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| 3 | College | 529, UGMA, UTMA & Non-qualified |
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| 2 | Retirement | Pension, IRA & Non-qualified |
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| 1 | Specific Goals | Non-qualified |
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| Emergency Reserves
| Savings |
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| Summary |
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| It is important for every investor to understand the different types of investment options available to them and to fit those options into their financial plan. Your eFinplan financial plan will help you establish your individual priorities so that you can prioritize your investments wisely. |
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| Kent E. Irwin is CEO and founder of eFinplan, LLC. He is also a Chartered Financial Consultant (ChFC), a Chartered Advisor in Philanthropy (CAP) and a Chartered Life Underwriter (CLU). He can be reached at
This e-mail address is being protected from spam bots, you need JavaScript enabled to view it
. For more information about eFinplan, go to the website efinplan.com. |
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| Copyright © 2007 eFinplan, LLC. All Rights Reserved. |
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