Retirement planning is one of those things that’s always better to start early, but figuring out where to put your money can be confusing.
In the U.S., there are several types of retirement accounts, each with its own benefits and restrictions. Let’s break down some of the most common ones—like the 401(k) and the IRA—to help you understand how to make the most of them when planning for your future.
401(k): A Workplace Retirement Plan
A 401(k) is one of the most popular retirement accounts, especially if you work for a company that offers it. It allows you to save and invest for retirement with tax advantages. There are two main types of 401(k)s: traditional and Roth.
Traditional 401(k):
- How It Works: You contribute pre-tax money from your paycheck. The amount you contribute lowers your taxable income for the year, which can help reduce your overall tax bill.
- Tax Benefits: You only pay taxes when you withdraw the money in retirement. This means your money grows tax-deferred while it’s in the account.
- Contribution Limits: For 2024, you can contribute up to $22,500 per year if you’re under 50. If you’re 50 or older, you can contribute an additional $7,500 as a catch-up contribution, bringing the total to $30,000.
Roth 401(k):
- How It Works: Contributions are made with after-tax dollars, so you don’t get a tax break upfront. However, your withdrawals in retirement are tax-free.
- Tax Benefits: The biggest perk here is that you don’t pay taxes on your withdrawals, which can be a big advantage if you expect to be in a higher tax bracket when you retire.
- Contribution Limits: The same contribution limits apply to Roth 401(k)s as traditional 401(k)s.
Employer Match:
Many employers offer a 401(k) match, meaning they’ll contribute a certain percentage of your salary to your 401(k) based on how much you contribute. This is essentially free money and one of the best perks of having a 401(k) account.
IRA: Individual Retirement Account
An IRA is another popular option for retirement savings. Unlike the 401(k), which is typically offered through your employer, an IRA is something you open on your own. There are two main types of IRAs: traditional and Roth, similar to the 401(k) options.
Traditional IRA:
- How It Works: Like a traditional 401(k), you contribute pre-tax dollars to the account, and the money grows tax-deferred.
- Tax Benefits: Contributions may be tax-deductible in the year you make them, reducing your taxable income. You pay taxes when you withdraw the funds in retirement.
- Contribution Limits: For 2024, the contribution limit is $6,500 if you’re under 50, and $7,500 if you’re 50 or older.
Roth IRA:
- How It Works: With a Roth IRA, you contribute after-tax money, so you don’t get a tax deduction when you put money in. However, your withdrawals in retirement are tax-free.
- Tax Benefits: The big advantage here is that your withdrawals are completely tax-free if you meet certain conditions (like being 59½ or older and having the account for at least five years).
- Contribution Limits: The same contribution limits apply to Roth IRAs as traditional IRAs. However, Roth IRAs also have income limits, so if you earn too much, you may not be eligible to contribute directly.
Key Differences Between 401(k)s and IRAs
| Feature | 401(k) | IRA |
|---|---|---|
| Offered by | Employer | Individual |
| Contribution Limits | $22,500 ($30,000 if 50+) | $6,500 ($7,500 if 50+) |
| Tax Benefits | Pre-tax (Traditional) or tax-free (Roth) | Pre-tax (Traditional) or tax-free (Roth) |
| Tax on Withdrawals | Taxed as ordinary income (Traditional) or tax-free (Roth) | Taxed as ordinary income (Traditional) or tax-free (Roth) |
| Employer Match | Often available | Not available |
Which Retirement Account Should You Choose?
Choosing between a 401(k) and an IRA depends on your personal situation. If your employer offers a 401(k) with a match, it’s usually a good idea to take advantage of it because that’s essentially free money.
If you want more control over your investment options, an IRA can be a great choice. Some people choose to contribute to both to maximize their retirement savings.
No matter which option you choose, the key is to start saving as early as possible. Even small contributions can grow significantly over time thanks to compound interest.
So, take a look at your options, consider your goals, and start building your retirement plan today.