Think of your Future
One of the concepts to reach our financial independence is investment. It is a purchase of something that is paid by money or anything with monetary value that has the potential to grow from the initial capital outlay. Buying things that would depreciate its value overtime is not considered an investment. Buying a car, furniture which loses value due to wear and tear are not an investment. However, buying a house, jewelries, stocks, bonds and properties with the intention to make money are considered an investment. Their growth potential varies depending on their risk profile. The greater the risk, the greater the return of your investment (ROI).
Investments are categorized into group according to their level of risk. We have cash-equivalent investments which include savings account, money market funds. The second category is low-risk investments which include bonds and CD. The third is a high-risk investments which include stocks, options, futures, index funds, currencies, commodities, and etc.
Other investments are real estates , buying properties or land so that over time you will profit due to increase value of the properties.
Can you handle investment risk?
Individuals have different tolerance to risk with regards to their investments. Some are risk takers, others are not Can your stomach handle the amount of variability and fluctuation in your investments.
An individual retirement account (IRA) in the United States is a form of “individual retirement plan”, provided by many financial institutions, that provides tax advantages for retirement savings. It is a trust that holds investment assets purchased with a taxpayer’s earned income for the taxpayer’s eventual benefit in old age. An individual retirement account is a type of individual retirement arrangement as described in IRS Publication 590, Individual Retirement Arrangements (IRAs). Other arrangements include employer-established benefit trusts and individual retirement annuities, by which a taxpayer purchases an annuity contract or an endowment contract from a life insurance company.[
There are several types of IRAs:
- Traditional IRA – Contributions are often tax-deductible (often simplified as “money is deposited before tax” or “contributions are made with pre-tax assets”), all transactions and earnings within the IRA have no tax impact, and withdrawals at retirement are taxed as income (except for those portions of the withdrawal corresponding to contributions that were not deducted). Depending upon the nature of the contribution, a traditional IRA may be a “deductible IRA” or a “non-deductible IRA”. Traditional IRAs were introduced with the Employee Retirement Income Security Act of 1974 (ERISA) and made popular with the Economic Recovery Tax Act of 1981.
- Roth IRA – Contributions are non-deductible and transactions within the IRA have no tax impact. The contributions may be withdrawn at any time without penalty, and earnings may be withdrawn tax-free in retirement. Named for Senator William V. Roth Jr., the Roth IRA was introduced as part of the Taxpayer Relief Act of 1997.
o myRA – a 2014 Obama administration initiative based on the Roth IRA
- SEP IRA – a provision that allows an employer (typically a small business or self-employed individual) to make retirement plan contributions into a Traditional IRA established in the employee’s name, instead of to a pension fund in the company’s name.
- SIMPLE IRA – a Savings Incentive Match Plan for Employees that requires employer matching contributions to the plan whenever an employee makes a contribution. The plan is similar to a 401(k) plan, but with lower contribution limits and simpler (and thus less costly) administration. Although it is termed an IRA, it is treated separately.
- Rollover IRA – no real difference in tax treatment from a traditional IRA, but the funds come from a qualified plan or 403(b) account and are “rolled over” into the rollover IRA instead of contributed as cash. No other assets are commingled with these rollover amounts.
- Conduit IRA – Tool to transfer qualified investments from one account to another. In order to retain certain special tax treatments, funds may not be commingled with other types of assets, including other IRAs.
The last two types, Rollover IRAs and Conduit IRAs, are viewed by some as obsolete under current tax law (their functions have been subsumed by the Traditional IRA), but this tax law is set to expire unless extended. However, some individuals still maintain these arrangements in order to keep track of the source of these assets. One key reason is that some qualified plans will accept rollovers from IRAs only if they are conduit/rollover IRAs.
A self-directed IRA is considered the same by the tax code, but refers to IRAs where the custodian allows the investor wider flexibility in choosing investments, typically including alternative investments. Some examples of these alternative investments are: real estate, private mortgages, private company stock, oil and gas limited partnerships, precious metals, horses, and intellectual property. While the Internal Revenue Code (IRC) has placed a few restrictions on what can be invested in, the IRA custodian may impose additional restrictions on what assets they will custody. Self-directed IRA custodians, or IRA custodians who specialize in alternative investments, are better equipped to handle transactions involving alternative investments.
Some IRA custodians and some investment funds specialize in socially responsible investing, sometimes using public environmental, social and corporate governance ratings.
Starting with the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), many of the restrictions of what type of funds could be rolled into an IRA and what type of plans IRA funds could be rolled into were significantly relaxed. Additional legislation since 2001 has further relaxed restrictions. Essentially, most retirement plans can be rolled into an IRA after meeting certain criteria, and most retirement plans can accept funds from an IRA. An example of an exception is a non-governmental 457 plan which cannot be rolled into anything but another non-governmental 457 plan.
The tax treatment of the above types of IRAs (except for Roth IRAs) are very similar, particularly for rules regarding distributions. SEP IRAs and SIMPLE IRAs also have additional rules similar to those for qualified plans governing how contributions can and must be made and what employees are qualified to participate.
In the United States, a 401(k) plan is an employer-sponsored defined-contribution pension account defined in subsection 401(k) of the Internal Revenue Code. Employee funding comes directly off their paycheck and may be matched by the employer. There are two main types corresponding to the same distinction in an Individual Retirement Account (IRA); variously referred to as traditional vs. Roth, or tax-deferred vs. tax exempt, or EET vs. TEE. For both types, profits in the account are never taxed. For tax exempt accounts contributions and withdrawals have no impact on income tax. For tax deferred accounts contributions may be deducted from taxable income and withdrawals are added to taxable income. There are limits to contributions, rules governing withdrawals and possible penalties.
The benefit of the tax-exempt account is from tax-free profits. The net benefit of the tax deferred account is the sum of (1) the same benefit from tax-free profits, plus (2) a possible bonus (or penalty) from withdrawals at tax rates lower (or higher) than at contribution, and (3) the impact on qualification for other income-tested programs from contributions and withdrawals reducing and adding to taxable income. As of 2019, 401(k) plans had US$6.4 trillion in assets.