Demystifying Retirement Accounts: 401(k)s, IRAs
As you approach graduation and enter the workforce, you’ll encounter terms like 401(k), IRA, Roth, and traditional accounts. Understanding these concepts is important for your long-term financial future. In this article, we will begin demystifying retirement accounts to help you gain better understanding.
What is a 401(k)?
A 401(k) is an employer-sponsored retirement savings plan. It’s like an investment shopping cart where you can choose various investment options. These investment options can be anything from a savings account, to an individual stock option.
What is an IRA?
An Individual Retirement Account (IRA) is an individually opened and managed retirement account. One important feature of this plan is that it has lower contribution limits compared to employer plans. The maximum contribution for individuals under 50 is $7,000 in 2024.
IRAs do not include an employer match, so individuals solely fund contributions, unlike 401(k) plans. One big advantage of an IRA is the many investment options available. This allows for more flexibility in how to invest money to grow retirement savings.
Traditional vs. Roth: Understanding the Difference
Both 401(k)s and IRAs come in traditional and Roth versions.
Traditional 401(k)/IRA
- Contributions are made with pre-tax dollars, reducing your current taxable income.
- You pay taxes on withdrawals in retirement.
- Best if you expect to be in a lower tax bracket in retirement.
Roth 401(k)/IRA
- Contributions are made with after-tax dollars.
- Withdrawals in retirement are tax-free.
- Best if you expect to be in a higher tax bracket in retirement.
While retirement may seem far off, the decisions you make now about 401(k)s and IRAs can have a large impact on your financial future. Take advantage of employer matches, understand the differences between account types, and also start saving early. After all, your future self will thank you for the financial security you’re building today.
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