Starting to really look into my retirement, and trying to figure out the baseline differences between these:
401(k)
Traditional IRA.
Roth IRA.
SEP IRA.
Simple IRA and Simple 401(k)
Solo 401(k)
My company provides a basic 401(k) that I never put much thought into, just set an amount monthly to contribute and that was that.
In: 15
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Most companies hold periodic education sessions on your 401k. I would recommend you attend one.
In simple terms, a 401k is a retirement plan through your work. Usually they pitch in a little bit. For example they might match your contributions dollar for dollar up to a certain amount.
An IRA is a retirement plan that you create on your own. The current limit is $6000 per year that you’re allowed to put in this. It’s basically a special account that says that you don’t pay taxes on the money you put into it until you withdraw.
A Roth IRA is just like an IRA but you pay taxes now and then your investment grows tax free.
Bear in mind that these are all just vehicles for your retirement investing. You have to actually buy stocks or bonds, a 401k on its own is just a container for your investment and not an investment itself. These various plans just say that you get to have special tax bonuses if you follow some rules the government laid out.
With all of these accounts it is usually difficult to remove the money before retirement age and there are penalities if you do. This is so you will actually keep the money saved for retirement instead of just pulling it out whenever you feel like it.
Disclaimer, I’m not an expert. The most common basic accounts are an Ira and 401k.
A 401k is available through your employer. Your employer doesn’t directly run it, but they choose the company that runs it. The money comes directly out of your paycheck before you even get it. Employers also sometimes match your contributions (if you put in $100 so will the) or even put in money on their own. If you change employers you’ll change 401k providers and accounts.
By comparison, an IRA (individual retirement account) is not linked to your employer. (Please note that I’m not as familiar with this account) Instead, you go find a company and open one. You have to manually contribute the money from your personal bank accounts (I think, I don’t have one). Because it’s not linked to a job, you get full control over it and it won’t change if you change jobs. Both IRAs and 401ks have limits n how much you can put in them a year, but they’re different.
Traditional vs Roth refer to different types of tax benefits and you can either 401k or ITA in both. In a traditional, you don’t pay taxes on the money you contribute. So if you make 70k and put in 5k, you pay income tax on 65k. However, when you retire, you pay taxes on that investment (so 10k as an example). You’re paying less taxes right now, but have to pay taxes when you take money out during retirement. In a Roth, you pay taxes on the full 70k now, but you don’t pay any on the 10k when you retire.
I’m not as familiar with the sep, simple, and solo plans, by the they’re geared towards small businesses or self employed people. If you’re not self employed, or work for a small business, you might not ever interact with these.
None of these are exclusive, you can have a Roth IRA and a 401k. Personally, I have a roth 401k and Roth IRA.
Make sure you’re actually investing the 401k money. 401k is a type of account, not an investment in itself. It might have just gone into a savings account type thing if you didn’t do anything. You probably want to out it into a better investment.
401k: You (and maybe your company) put in $10000 before federal income taxes get paid, so you aren’t taxed on that income. While you wait to retire, that $10000 (hopefully) grows tax-free. When you eventually retire, it’s grown into $50,000. If you withdraw $5000 after retiring, that counts as income and is taxed as income.
Traditional IRA: You put in $10000 before federal income taxes get paid, so you aren’t taxed on that income. While you wait to retire, that $10000 (hopefully) grows tax-free. When you eventually retire, it’s grown into $50,000. If you withdraw $5000 after retiring, that counts as income and is taxed as income.
Roth IRA: You put in $10000 after federal income taxes get paid, so you’ve been taxed on that income. While you wait to retire, that $10000 (hopefully) grows tax-free. When you eventually retire, it’s grown into $50,000. If you withdraw $5000 after retiring, it doesn’t count as income and isn’t taxed.
Simple IRA: A traditional IRA you and your company can put money into.
SEP IRA: A traditional IRA your company can put money into but you can’t.
Simple 401k: a 401k your company is required to put money into
Solo 401k: a 401k for a company owner
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Generally, your best bet would be to contact your employer and see if they offer a training course. Most will around the time of benefit enrollment, often around the end or start of the year. You could also contact the brokage that provides your 401(k) as they often have financial advisors that are included with the 401(k) plan for limited usage.
For the most basic, and common, types, there are two axis: 401(k) versus IRA and Traditional versus Roth. All four permutations are valid and reasonably common. All of the variations have you investing in the stock or bond market in various investments from money you put into the account.
A 401(k) is provided by your employer where you put money into the account, often with the employer putting some in as well, typically in the form of a match (eg, if you put in 5% of your wages, the employer will put in 4%). Most will offer a “target year” fund that is designed to be a decent investment vehicle for people looking to retire around the specified year. Most will also have a number of other investment options that go well beyond an ELI5 level – this is where talking with a financial advisor is required.
An IRA is opened by you directly with a brokerage and almost always has no connection to your employer. Generally, you can invest the money in an IRA into any investment available on the general markets, meaning stocks, bonds, and mutual funds. Again, the details of the investments go well beyond the ELI5 level.
Traditional versions of them have you pay no taxes on the contributions now or as you trade the funds around, however you pay taxes when you withdraw the money.
Roth versions have you pay taxes on the contributions as you make them, but you pay no taxes at any later time.
Both have their advantages and disadvantages, and you often want some degree of mixture of the two types. As with the investments, the details here go well beyond ELI5 level.
All types of accounts additionally provide some protection from creditors and bankruptcy. Notably, outside of fraud or illegal activity, the money in the accounts is not considered during debt collection or bankruptcy proceedings until you actually willingly withdraw it.
In exchange for the tax benefits and legal protections, you generally cannot withdraw the money until you reach a certain age or meet certain other conditions (eg, disability) without paying a fairly steep tax penalty *on top* of whatever taxes you’d normally need to pay on the money.
You can typically contribute to both a 401(k) and a Roth IRA account if you have the money, though contributions to a Roth IRA phase out at high income.
Now, onto the more uncommon types of retirement plans:
SEP IRAs are typically used by very small employers that are not large enough to warrant other types of plans, but still want to provide a retirement benefit to multiple employers. They are simpler and cheaper than the other types of employer plans, but require the employer to make identical contributions to all employees and the employer cannot have any vesting schedule. Employees cannot directly contribute to a SEP IRA – only the employer can, so employees are likely to also have a normal IRA as well.
SIMPLE IRAs are good for small employers, with a legal limit around 100 employees. Like a SEP IRA, SIMPLE IRAs are much cheaper and easier for an employer to setup than a 401(k). Like a 401(k), employees can contribute to the account and employers can have varying contributions between employees, though the variation much be tied to wages paid.
Solo 401(k), which also goes by a few other names, is a 401(k) plan for self-employed people or those owning a business with only themselves as an employee. These are much easier and cheaper to setup and run than a normal 401(k), and also allow the person to contribute additional money tax-free than just having an IRA.
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