Updated: Mar 22, 2019
Many people don't invest for retirement because they aren't sure of what options are available to them, or if they do, don't know which one is best for their situation. In this article, I present the most common retirement savings accounts that are out there.
401(k)s are offered by companies to their employees. Your contribution to your 401(k) retirement account is deducted from your paycheck as a certain percentage of the total amount. Some employers even match their employees contributions to their 401(k)s, which is a great benefit if your company provides that. For example, some companies will match up to 3%, which means that if you contribute 3% of your paycheck to your 401(k), the employer will also contribute the same amount to your 401(k). If you contribute 2%, the employer only matches 2%, and if you contribute 4%, your employer only contributes the maximum 3%. But these percentages vary by company. In 2019, your contribution to your 401(k) is limited to $19,000. If you’ve already invested $19,000 and want to invest more (nice job saving!) you’ll have to go elsewhere, like an IRA.
An IRA, or Individual Retirement Account, is available to almost everyone. You can open an IRA at most banks or with an online investment company. Each individual can contribute a total of $6000 per year ($7000 per year if you are over 50 years old) to their IRAs. However, you can only contribute to IRAs up to the amount of your taxable income (refer to the IRS website for the definition of taxable income). So if you only make $5000 of taxable income in a year (say you’re a teenager working part-time as a cashier), then you can only contribute $5000 in a year. The exception to this rule is for married couples. If one spouse receives over $12,000 in taxable income while the other is a homemaker, you are allowed to contribute $6000 to each spouse's IRA.
Another great thing about IRAs is that you can start saving for retirement as soon as you start earning taxable income. So if you’re in high school with a part-time job, you can save for retirement (and take advantage of many extra years of growth!) Or, if you have the cutest baby around who is making money as a baby model, you can contribute to a Roth IRA for them too!.
Traditional vs. Roth
There are two kinds of 401(k)s and IRAs - traditional and Roth. A Roth IRA or Roth 401(k) means that you contribute after-tax dollars of your income, and then your contribution is allowed to grow and be withdrawn in retirement tax-free. A traditional IRA or traditional 401(k) differs in that you contribute pre-tax dollars of your income. Your retirement savings (investment) can then grow tax-free, but is taxed when you withdraw it during retirement. Also, traditional accounts require that you take distributions (withdrawals) from your traditional account during retirement, whereas Roth accounts can be untouched, becoming a vehicle for passing wealth on to your descendants or spouse, similar to a life insurance policy.
With this in mind, you are ready to start investing for retirement! Check out The Secret to Retiring as a Millionaire to explore which retirement accounts are ideal for your own situation.