401(k)s and IRAs
Whether you’ve just graduated or have been in the workforce a while, retirement planning can be a bit overwhelming. But even a little bit goes a long way.
There are many options for saving. You could set up a savings account or hey, even dig out that old piggy bank. But when it comes to retirement plans, there are two terms you’ve probably heard a lot — 401(k) and IRA.
These accounts act as bins where you can save your money and invest it in bonds, stocks, and mutual funds. These investments typically grow over time. So, not only are you saving money, but also you’re earning it too.
The 401(k) is a retirement account offered by many employers for full-time employees. You can put a portion of your paycheck into the account, and you won’t pay taxes on that money until you withdraw it when you’re older. That money is considered “pretax.” For example, if you make $50,000 a year and decide to put $5,000 into your 401(k), you’ll pay taxes for that year only on $45,000. But when you reach retirement age and start to take money out, your money and any earnings will be taxed. The maximum contribution to an account is $18,000 a year.
A highlight of the 401(k) account is that employers can match. A match is typically 50 cents to a dollar. So for every dollar you contribute to your plan, your employer will contribute 50 cents, but only up to a certain percentage point of your income. A typical match for an employer is about 6 percent of your total salary. If and how much an employer gives varies at each job. So if a program is available to you, might as well take advantage — it’s free money!
If you leave your job, there are three options for your 401(k): You can roll it into a new 401(k) account at your new job; you can roll it into an IRA account; or you can cash out. But when you cash out, you’ll have to pay taxes as well as a 10 percent penalty fee.
If your employer doesn’t offer a 401(k) or you’re still on the job hunt, you can set up an individual retirement account (IRA). A traditional IRA operates similarly to the 401(k). You place pretax dollars into the account, and then it can grow until you can take it out. The maximum contribution for an IRA is $5,500 a year.
Both a 401(k) and an IRA can be Roth accounts as well, the Roth IRA being the more common variety. The Roth works in the opposite way of a traditional retirement account. The money you put in is “after-tax,” meaning you’ll pay tax on your income before you make contributions to the Roth, but you’ll pay no tax on the earnings when you make withdrawals from the account in retirement. It’s a nice deal, but there are income limitations to opening a Roth IRA. For example, if your income exceeds $129,000 and you file taxes as “single,” you’re not eligible for a Roth.
You can make withdrawals without the risk of penalties starting at the age of 59 and a half. It’s possible to take your money out before then, but you’ll have to pay any taxes owed as well as a 10 percent penalty. Each plan has some exceptions. With a Roth IRA, you can take out the money you’ve contributed without a penalty, but if you take out more than that, any earnings could be subject to penalties and taxes.
Retirement accounts can be set up at almost any financial institution, such as a bank, a mutual fund company, or a brokerage firm. So whether you’re in the market to start saving for retirement or not, at least after watching this video, you can say, “Now I get it.”
