Investing 101

Understanding Different Retirement Account Options

Future Capital
April 12, 2021

Before you start saving for retirement, it’s important to understand the different account options. The three most popular retirement accounts are 401(k)s, Traditional IRAs and Roth IRAs. While all are tax-free retirement saving, there are different nuances for each:

1.    A 401(k) is an employer-sponsored retirement plan that allows you to contribute a percentage of your salary tax-free until withdrawal. While it is not mandatory for employers to offer401(k) accounts to employees, it is a great perk that makes the ability to save for retirement easy and painless. This is because the money comes directly out of your paycheck before the funds hit your bank account. If your employer doesn’t offer a 401(k), consider trying to negotiate for one in an upcoming review, or even the next time you are job hunting. Employers often match the funds you contribute up to a certain percentage, which increases your ability to save quickly for retirement.

2.    If your employer does not offer a 401(k), not to worry! Most banks and credit unions offer IRA accounts. There are two different kinds:

a.    With a Traditional IRA, the money you deposit may be tax deductible, and earnings accumulate tax-free. However, you pay income tax when you withdraw the funds.

b.     With a Roth IRA, earnings also accumulate tax-free, and no taxes are paid for 5 years when the money is withdrawn in retirement. You can also withdraw money saved anytime without penalty, but earnings will face a penalty before retirement. But keep in mind that Roth IRAs are best suited for entry-level investors, as investors who earn more than a certain amount cannot invest in a Roth without aRoth IRA conversion, which can be complicated and comes with certain tax implications.

Regardless of which retirement account you choose, there are annual limits to keep in mind for each (if you have a Roth and Traditional IRA, your annual limit would be split between the two, not doubled). Your 401(k)also has its own limits, but that is not impacted by your IRA contributions.Whichever account you decide to go with, you should congratulate yourself for making an investment in your future.

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