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Every industry has its jargon. Which can be annoying AF for the rest of us “outsiders”.
Medical pros call simple ankle swelling “peripheral oedema” and came up with the term “iatrogenic” to describe when something doesn’t go as planned.
And then if tests come back showing you didn’t have the condition you were tested for, they call it a “negative” test result. I dunno. If I get tested for crabs and the test shows I don’t have crabs… that sounds pretty positive to me.
And don’t even get me started on the legal profession. Ever try to get through any legal document written by an attorney? Holy crap! You need a legal dictionary AND meth to pull that one off.
The world of investing is no different. And that’s the way many investing professionals like it.
Cuz the less you understand… the more confused you are… the more they can get away charging high fees and selling investment products most folks have no business putting their hard earned dough into.
Here at BuildYourOwnNestEgg.com, our mission is to make it easy for the average Joe/Jane to understand how to invest. And if you’re gonna invest, you’ll need an investment and/or retirement account.
So, in this article, we’re going to lay out the most common types of retirement investment accounts you can open. And we’ll do it in plain English so even doctors and attorneys can understand 😉
The reason retirement investment accounts are good to have comes down to tax savings. Either now, or in the future, by putting your money in a retirement account, you’ll save on taxes.
That can add up to some big savings. Savings that’ll go toward your retirement instead of lining the government’s piggy bank.
Now those savings can come at a price. See, once you put your money in a retirement account, you need to leave it there until you get to retirement age.
If you take it out before then, you’ll get hit with both penalties and taxes. Which blows.
(And in an emergency where you need cash, it’s a hit you may have to take.)
But, point is, if there’s money you think you’ll need before you retire, don’t stick it in a retirement account.
Okay, with that out of the way, let’s look at the main types of retirement accounts you can open…
If you work for a company that offers a 401(k) retirement plan, that’s probably your best place to start socking it away for retirement.
This plan is opened by your employer on your behalf (and, don’t worry, if you leave the employer, the money is still yours!).
You decide how much you want to contribute from your paycheck each billing period (though there are limits on how much you can contribute). That money is then automatically put in your retirement account each pay period.
This money gets deducted from what you pay taxes on each year. So if you make $50,000 and put $5,000 into a 401(k) plan, you’ll only pay taxes on $45,000.
You can start taking money out of your 401(k) when you’re 59 ½ (which will probably be the first time you cared about the ½ since you were 4 ½!). At that point, the money is taxed the year you take it out of your 401(k).
The idea here is you’ll be in a lower tax bracket when you’re retired so you’ll end up paying less in taxes at that point.
The sweetest part of a 401(k), however, is if you work for a company that offers an “employer match”.
Basically this means your employer adds additional money to your 401(k) over and above what you put in there.
How this works and how much money an employer will drop into your 401(k) depends on your company’s plan. But, bottom line, it’s FREE money. And if your employer is gonna give you free money, you might as well take it.
Now 401(k)s aren’t all rainbows and unicorns. There are some downsides.
The biggie is they usually have a limited number of investment options. And they ain’t always good ones.
Often you’ll find mutual funds with high fees and questionable performance (Tip: If you can find an index fund or two in your 401(k), that’s typically the best way to go).
On top of that, 401(k)s also can have high administrative and management fees.
The result of these two negatives is they take money out of your pocket.
But if you get free money from an employer match, you should come out way ahead so it’s probably worth just sucking it up and going with your employer’s 401(k) plan.
If you work for a non-profit or an organization that doesn’t have to pay taxes (legally, that is), you’ll get offered a 403(b) instead of a 401(k). They work the same way. Everything I wrote about the 401(k) applies to a 403(b) so I ain’t rehashing it again J
You don’t have to go through an employer to open a retirement account. You can do it yourself.
Many brokerage firms allow you to open IRAs. These are accounts you can use to enjoy tax savings AND have the flexibility to choose the mutual funds (and even stocks) you want to invest in.
There are two main types of IRAs to choose from:
The tax savings for a Traditional IRA are similar to what we talked about for a 401(k). They lower your taxable income the year you make your contribution.
But, as with the 401(k), you’ll end up paying the taxes when you withdraw that money during retirement (or pay taxes and penalties if you take it out before age 59 ½).
Also, for Traditional IRAs, there are no income limits on contributions. So whether you make $10,000 or $10,000,000 you can sock money away in a Traditional IRA. (However, if you or your spouse has a retirement plan at work, you may not be able to deduct your traditional IRA contributions.)
Roths are a stellar option for those who are eligible.
And who’s eligible?
In 2021, it’s anyone who’s single and makes less than $125K a year or less than $198K if you’re married.
If you are eligible, a Roth IRA is a retirement account that you put after tax dollars into. But, once you put the money in there, it grows tax free. Yep. You won’t owe taxes on any money in that account. Ever.
No matter how much in investment returns you rack up on that money.
Pretty sweet, right?
Oh, and if you make too much money to put your money into a Roth IRA, there’s a way around it. It’s called a backdoor Roth IRA. It may sound like some weird Irish sex game, but it’s actually a legal way to put money in a Roth for those with high incomes.
So, if that’s you, good on ya! And check into a backdoor Roth IRA to see if it makes sense.
You can open up a regular ol’ brokerage account and use it as a retirement account. The downside of this is you won’t get any tax savings.
The upside though is that you won’t have any income limits to worry about. And, if you want to take money out before you retire, you won’t get screwed by penalties.
The most important thing when it comes to saving for retirement is to just get started. Put a little money away on a regular basis. Cuz the sooner you start, the more your money has time to grow and the more dough you’ll have to splurge on your grandkids, travel and adult diapers when you retire.