When you go through the process of opening an account with a brokerage firm like TD Ameritrade, Tastyworks, or Fidelity, one of the first questions asked is which account type you’d like to use.

Today I want to provide a high-level overview of 4 of the more popular account types: Individual, IRA, Roth IRA, Solo 401(k). Bear in mind, I’m not an accountant or tax professional. And tax laws can change. My comments below are meant to be a general introduction to the topic, not an exhaustive overview. Nor is it individualized to you.

I’m borrowing some of the explanations from TD Ameritrade’s Account Types page. You can find it here.

Individual Account

This is the first account I opened up. Per Ameritrade, “An individual account is a standard brokerage account with only one owner.” All capital gains and dividends are taxable.

Provided you meet the minimum account size (for TD, it’s $2,000), you can access margin and options privileges. Futures and Forex are also on the table. Which specific options strategies you can do is a function of your trading authority. TD Ameritrade has 3 Tiers (it’s technically 4!), as shown below:

You can find your Tier on their website under Client Services, My Profile, Investor Profile.

The other three account types we’re discussing are considered retirement accounts, which means they offer various tax benefits. Keep in mind, that you’ll need to keep up on any changes in the tax law. Your broker should update their limits/regulations to reflect them, though.

Traditional IRA

This account type may provide an immediate tax benefit because contributions are usually tax-deductible. For those that qualify, up to $6,000 of tax-deferred income can be put in the account. If you have a non-income-earning spouse, you can contribute another $6,000 in a separate IRA for him/her. Individuals over age 50 are allowed to deposit an additional $1,000 as a “catch-up” contribution.

When we say the account grows tax-deferred, it means you don’t have to pay taxes on dividends or capital gains until you withdraw the money in retirement.

If you’re wondering if there’s a trade-off for the tax advantages, there is. You typically can’t withdraw money from the account until age 59 1/2. If you do, there will be a 10% penalty.

There are some trading restrictions in an IRA account. I’ll list the two main ones below. Aside from these, you pretty much trade any other options strategy.

One: You can’t buy stocks on margin.

Two: You can’t short stocks.

Three: You can’t sell naked puts (they are considered “cash-secured”), and with most brokers, you can’t sell naked calls.

ROTH IRA

In a Traditional IRA, you’re investing pre-tax money, and it grows tax-deferred. With a ROTH IRA, you’re investing post-tax money, and it grows tax-free. Uncle Sam takes his bite one way or the other. He’s a hungry fella.

The contribution limits ($6,000 in 2020 plus $1,000 catch-up) are identical to the Traditional IRA, and you can set up and fund an account for a non-income-earning spouse.

I started a ROTH IRA when I was in my mid-twenties, opting for it over the Traditional IRA for two reasons. First, I was in a low tax bracket. So why not pay the minimal tax on my contribution now and let it grow tax-free for decades? The second reason was because of liquidity. I really don’t like the 10% penalty you suffer if something comes up and you need to tap into the money in a Traditional IRA. Fortunately, with the ROTH, you can withdraw contributions any time you want without penalty! That makes it much more flexible.

My spouse also has a ROTH IRA, and my top priority every year is to fund hers and mine.

The trading restrictions in the traditional IRA also apply to the ROTH.

Solo 401(k)

For low-income earners, using IRAs might be sufficient. If you open one for yourself and your spouse, you can sock away $13,000 combined for investments to grow tax-deferred or tax-free. But as your income rises, you may find that you’re able to save more than $13,000 annually. With the excess, you have a few choices. First, you could put it in the Individual Account mentioned above. On the positive side, it’s liquid and accessible. On the negative side, there aren’t any tax benefits.

Second, you might be eligible to open up a Solo 401(k) account. It primarily depends on if you own a business or not. Here’s how Ameritrade explains it:

“A Solo 401k retirement plan offers the maximum retirement contribution (limits or levels) for self-employed individuals. This retirement plan has high contribution limits and flexible investment options.

The Solo 401k allows owners to make both employer and employee contributions, providing owners the ability to maximize their personal retirement contributions and their business deductions. Since there are no employees, there are no compliance testing requirements.

This is why a Solo 401k is most suitable for self-employed individuals or a business owner with no additional employees other than a spouse or a child. Consider this type of plan if your business has irregular profit patterns.

Eligible businesses include sole proprietorships, partnerships, and incorporated businesses.

Solo 401(k) specs

There is more paperwork on the front-end to establish a Solo 401(k). And unlike IRAs, your contributions have to go through your business payroll.

On the trading side, the IRA limitations apply to a 401(k) as well. So no margin, shorting stock, or naked options. Other than that, everything else is fair game.

I have an S corporation and set up a Solo 401(k) years ago. I needed my accountant to help with the paperwork and have to communicate to him how much of my payroll I want to be squirreled away into the 401(k). Because of the extremely high contribution limits, in years where you make a lot of money, it gives you a lot of control over your taxable income.

As you’ll discover when exploring account types, there are many others. In my experience, these are the most common. As always, let me know if I missed anything or if you have any questions.

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