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As a young adult, it can be daunting to try to find information about the best way invest for the long term – specifically retirement accounts. I know, it’s easy at this stage to think “I have tons of time to start thinking about getting my finances in order!” and - it's hard to sort through all the information out there to get down to the basics of what you need to know.
In this blog, I'm going to break down four retirement accounts (there are many more) and give you some facts to help you understand your options. This is by no means meant to be a comprehensive list of information. My goal for this post is to create a starting point that you can use to jumpstart further research into the type of account or accounts that will best work for you.
Types of retirement accounts:
401(k) and Traditional IRA: Contributions are made before being taxed (saving you taxes upfront) and your money grows tax deferred
- The money is taxed when you withdraw it for retirement
- 401(k)’s are sponsored through employers; however, not every employer offers one
- An IRA is a good choice for people who do not have access to a 401(k) or other retirement plans at work
Roth 410 (k) and Roth IRA: Contributions are made with money from your paycheck that has already been taxed, so it’s tax free to withdraw during retirement if certain criteria are met.
- If you believe you’re in a lower tax bracket now than you will be later, it’s smart to choose the Roth option and pay the taxes now instead of later.
- Not everyone qualifies for a Roth account, you must meet certain salary requirements.
Where to Start: Does your employer offer a 401(k)?
- If your employer does offer a 401(k) plan take advantage of it, especially if they offer a match. Put in enough money to get the maximum match. If you have maximized your 401(k) contribution and still have more you want to put into savings, review whether you are eligible to contribute into a personal IRA or Roth IRA. Depending on your income you may or may not be eligible to do so.
What to Know About Your 401 (k) Plan:
- Employer's 401k plan documents: What you need to find out -
- When you can contribute
- Company match- is there one? And if so, what are the rules
- How much can you contribute
- Investment options offered
- Maintenance costs and fees
- Roth options- if available, do you qualify and is it a good option for you currently?
- What happens to your money if you leave the company
- If your employer offers a 401(k) match, put in enough money to get the maximum match
- Bonus note: you are lowering your taxable wage base in the process
What to Know About Your IRA Plan:
- Opened individually at a brokerage or bank
- Without access to an employer available 401(k), an IRA is a smart choice to start your retirement savings
- Do you qualify for a Roth IRA?
- Do you qualify for full, partial, or no deduction of taxes based on your salary?
Contribution limits:
Below Age 50 Above Age 50
2019 Contribution Limits 401(k): $19,000 $25,000
2019 Contribution Limits IRA: $6,000 $7,000
Don't take early withdrawals!
- Roth 401(k)’s and Roth IRA’s are only tax and penalty free upon withdrawal if the account has been held for five years or longer and withdrawal is made in the event of disability, death, or the account holder is above 59 and a half years old.
- If you wish to withdrawal money from your 410k before age 59 and a half, you must pay a 10% penalty fee on top of income taxes.
Final Thoughts:
Do: Start ASAP, Increase Contributions, Rebalance Annually and Diversify
Don't: Time the market, cash out early, or Take a 401(k) loan
If you can't max out both a 401(k) and an IRA in a year, max out the 401(k) first to get the total employer match and then put as much as you can (if eligible) into an IRA.
If your employer does not offer a match, still consider maxing out your 401(k). If your 401(k) has a Roth option, consider whether you are in a lower tax bracket today than you will be in the future. If so, consider using the Roth 401(k) option.
Start saving now!If you read through this information and thought "That was useful, but I probably won't start savings for another couple of years" rethink that logic! No matter your age, you are never too young to start saving for retirement. Compounding interest is your best friend. The earlier you start saving, the easier it will be for you to accumulate a healthy nest egg.
Tools and Resources:
Take a look at our calculator to see how you can grow your retirement savings with early planning.
Further Resources for Information
- https://www.nerdwallet.com/blog/investing/best-retirement-plans-for-you/
- https://money.cnn.com/retirement/guide/IRA_Basics.moneymag/index.htm
- https://money.cnn.com/retirement/guide/401k_basics.moneymag/index.htm
Author: Kirsten Eddy, Junior Portfolio Analyst