IRAs and 401(k) Frequently Asked Questions
Retirement may seem far, but it is never too far to start saving for it. Whether you are 16 or 35, the time to open an IRA and 401(k) is now. This blog will answer the most frequently answered questions about IRAs and 401(k)s.
What is the difference between an IRA and 401(k) Account?
An IRA, or individual retirement account, is individually opened and managed by you. This type of account does not include any employer match and is solely funded by you. An advantage of this is that there are many investment options available, which allows more flexibility in how to grow your retirement fund.
A 401(k) is an employer-sponsored retirement savings plan. This means that your employer offers a certain percentage match of funds you put into the account. As time goes on, the percentage of what you own in that account, or vest, goes up until you own all of it.
Both of these accounts can be used at the same time, and is actually recommended so that you can maximize your retirement funds.
What is the difference between Traditional and Roth?
Both IRAs and 401(k)s come in traditional and Roth versions.
Traditional:
- Contributions to the account and made with pre-tax dollars, reducing your current taxable income
- You pay taxes on withdrawals in retirement
- This is the best option if you expect to be in a lower tax bracket in retirement
Roth:
- Contributions are made with after-tax dollars
- You do not pay taxes when withdrawing in retirement
- This is best if you expect to be in a higher tax bracket in retirement
How much can I put into the account each year?
This number depends on if it is traditional and Roth, as well as if it is a 401(k) or IRA. The IRS has contribution limits, which are:
- Traditional/Roth IRA: $7,000 each year ($8,000 if age 50 or older)
- 401(k): $23,000 each year (additional $7,500 each year if age 50 or older
At what age do I open an account?
The short answer is now! It is never too early to open an account, even if you aren’t 18 yet.
There are many options available for Traditional or Roth IRA accounts. Some examples of beginner ones include Acorns or Betterment. These online services allow you to invest spare change as well as create an investment profile based on your level of risk.
As you get older, you can adjust your investment profile as well as what service you use to invest. It is recommended that the younger you are, the more aggressive you are in your investment profile. This means that you have a higher percentage of your money going into a more risky investment category, like stocks.
In regards to a 401(k), it is best to always take advantage of it if your employer offers it with a percentage match. The earlier you start, the more time you will have to grow your retirement funds.
How do I open a 401(k) or IRA?
When you get started with a company, inquire about their 401(k) requirements and benefits. Talk to your employer about enrolling and make sure you know what the terms of the account are, such as what percentage they match.
To open an IRA, simply search around for the provider you want to use. Providers include banks, credit unions, and brokerages. Setting up an account is simple and easy.
How do I know how much I need to save for retirement?
Use our IRA calculator to find out how much you need to start saving today to have enough retirement funds when you retire. It is recommended to have enough to be able to withdraw each year or month to live off of, as well as have emergency funds and enough for anyone depending on you still. To get a rough estimate of what that number needs to be, use our retirement income calculator.
Are there fees for withdrawing funds?
If you are withdrawing from your 401(k) before age 59 ½, you will have you pay a 10% fee. There are some exceptions to this if it qualifies as a hardship, which is usually outlined in your employer plan provider.
For Roth IRAs, you can withdraw contributions at any time and at any age without penalties or taxes. This is great for sudden emergencies that may happen. Note, however, that this only applies to contributions, not earnings/market returns. If you withdraw earnings before age 59 ½, you will have to pay the 10% penalty as well as owe income tax.
For Traditional IRAs, you will have to pay a 10% penalty fee (before age 59 ½) as well as income taxes on the amount you withdraw, no matter if it is on contributions or earnings. This is because those initial contributions were deduced from your taxable income during the year.
When do I start?
Now that you know some of the frequently asked questions and what 401(k)s and IRAs are, open one today! Whether you can invest $10 a month or $500 a month, a retirement account is crucial for future security.
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