Investing isn't as scary as it sounds. While all investments carry risk, not all of them are equally risky. Before hitting the stock market with a tax-advantaged account, you can invest without taking too much risk and in places that might earn you more reward.
Most retirement and related accounts invest in the stock market, but through a combination of stocks, bonds, CDs, mutual funds and other types of investments. The benefit of investing through these types of accounts is that they're tax-free (or tax-deferred), leaving more money in your pocket. Before you play the market through a standard brokerage account, here are the investment accounts you should max out.
1. Max out your 401(k) match
Having a company-sponsored retirement plan is one of the easiest ways to start investing. 401(k) contributions are made from your salary pretax and are invested in predetermined funds, leaving all the guesswork and maintenance out of investing. Better yet, some companies offer an employer match, which is when your employer contributes extra cash to your retirement fund.
When you max out your 401(k) contributions, your employer will match your contributions up to a certain percentage, sometimes around 6%. The more money you can get from your company, the more you'll have when it comes time to retire. If your company doesn't offer a match, see if they have a plan available. At the very least, max out for your 401(k) contributions. For 2020, you can contribute as much as $19,500. Many companies' 401(k) account managers have tools to help you determine what contribution rate will get you to the max contribution.
2. Open an IRA
If you've hit your max contributions for your work-sponsored retirement plan or you don't have one available, open up a retirement account.
Individual retirement accounts, or IRAs, are best for people who either don't have a 401(k) option at their company, are self-employed or are looking for more ways to invest their cash. The two most popular are traditional IRAs and Roth IRAs (named for Sen. William Roth, the principal sponsor of the 1997 legislation that established the mechanism). The main difference is how you're taxed. For traditional IRAs, contributions and earnings are tax-deferred, but your distributions are taxed when you retire. Required minimum distributions kick in when you turn 70 and a half years of age, which is when you're required to make minimum withdrawals from your account. Roth IRAs are taxed upon contribution, or when you add funds to your IRA, and your earnings and distributions are tax-free. Roth IRAs don't have RMDs, so you don't need to withdraw unless you want to.
While you can have as many IRAs as you want, you can contribute only the annual maximum. For 2020, the maximum is $6,000. Roth IRAs are also subject to income limits. For 2020, your modified adjusted gross income needs to be less than $124,000 if you're filing singly ($196,000 if you're married filing jointly) in order to contribute the full $6,000. If you're above the earning threshold but still want a Roth IRA, you can open a traditional IRA and then convert it. This is called a backdoor Roth IRA.
3. Contribute to a health savings account
An HSA is a savings account that is specifically for health-related expenses. HSA contributions, earnings and distributions are all tax-free. If your employer offers an HSA, you can make contributions directly from your paycheck. HSAs are not FSAs (see below); FSAs are only offered through employers, while you can get an HSA on your own.
If you don't use the money in your HSA this year, you can roll it over to the next year. That way you can use it when a health need arises. HSA funds aren't only for emergencies; you can use them for most health, dental and mental health needs. For 2020, you can contribute up to $3,550 for individuals (or $7,100 for families).
HSAs are only available if you have a high-deductible health plan. If you have a lot of medical-related needs and need a lower deductible, an HSA might not be the best investment for you. But if you don't have a lot of health needs and want to save just in case one arises, this type of account may work for you.
4. Open a flexible spending account
Some companies offer flex spending accounts, sometimes called flex spending arrangements. FSAs let you contribute a portion of your earnings to qualifying expenses, like health care or dependent care.
FSA money must be used by the end of the year, although it's up to individual employers to grant a grace period to use it or lose it.
Because of COVID-19, many child care centers are closed, with many summer camps following along. That's caused many FSA providers to let you temporarily stop contributing if you planned to use your FSA for related child-care expenses. Maximum contributions vary depending on its purpose. For instance, if you use it as a health savings plan, you can contribute up to $2,750 (this amount is the same for families or single filers). For dependent care, you can contribute up to $5,000 for both individuals and those married filing jointly.
5. Contribute to a 529 plan
A 529 savings plan is an education savings plan that works like a Roth IRA. Your after-tax contributions get invested into different types of investments, like mutual funds. Earnings and distributions are tax-free, as long as they're used for qualifying education expenses.
Expenses aren't just limited to tuition and fees; you can also use it for room and board, moving, equipment and other related supplies. If you spend it on nonqualifying expenses, you could face a 10% tax penalty.
If you open a 529 plan for your child but they don't use it, you can transfer it to another family member (including yourself). You can use the funds to pay for college, but 529 funds can also go towards K-12 educational expenses, like charter or private schools.
There are also 529 prepaid college plans, which let you prepay for your child's tuition at today's rates. Since college costs increase every year, locking in rates for right now could save you from paying more by the time your child enters college. But they're only good for in-state public colleges and universities and they aren't widely available. Right now there are 18 prepaid tuition plans in the US.
Read more: 5 ways to save if you're afraid of investing