This Personal Finance 101 article focuses on upping your knowledge on all of the various retirement accounts that are available to people living in the US and Canada. If you are anything like me, you want to make sure that the next time a retirement account alphabet soup conversation starts up, you can jump right in with knowledge of the big players like IRA, SEP, 401k and so on. In fact, after reading this article, you’ll probably be able to school a few of your friends!

For this article we will cover the following account types IRA, Roth IRA, SEP-IRA, 401(k), 403(b) and RRSP. So without further ado, let’t dig in.

IRA (Individual Retirement Account)

An IRA or sometimes called a Traditional IRA (as opposed to Roth) is a special account designed for those trying to save money for retirement. It’s different than a regular savings account in that it has special tax advantages and they can allow you to invest in stocks, bonds, mutual funds and other securities. IRAs can be opened at most banks and brokerages. Depending on where you open it, you will have access to various funds to invest in. For example, if you open one at Vanguard, you’ll have access to Vanguard’s famous low-cost index funds as well as the ability to invest in individual stocks.

IRA Tax Implications

With a traditional IRA your contributions are tax-deductible, but withdrawals are taxed. The idea is when many people are at their peak earning potential they will be in a higher tax bracket than when they retire. So the IRA encourages them to sock money away now and then when you withdrawal from it during retirement you’ll end up paying less tax on the contributions and gains. The contributions grow tax-deferred.

At time of this writing, if you are under 50, you can contribute up to $5,500 and up to $6,500 if you are over 50 years old.

Roth IRA

The Roth IRA mainly differs from a traditional IRA by its tax rules. With a Roth IRA, your contributions are not tax deductible, but all of the subsequent gains, if you wait until you are 65, are tax free. Yep, that’s right, tax free! The Roth IRA is a super great retirement account because once you are retired you can withdrawal any of the money in there without worry about paying a single dime in taxes. If you can’t wait until 65, you can withdrawal your original contributions without tax consequences, just not the gains.

There are a few gotchas though. You can only contribute $5,500 to a Roth and traditional IRA. So you can’t contribute $5,500 to a Roth and $5,500 to a traditional IRA. Also, high-income earners won’t qualify for being able to contribute to a Roth IRA. (Although some people use what is known as a “backdoor Roth contribution” to get around this limitation.)

Just like a traditional Roth IRA. There are number of various ways to invest your contributions. You can use it with your own DIY investing strategy or hire someone to manage it for you.

SEP (Simplified Employee Pension)

A SEP is for business owners who want an easy way to contribute to their employees’ retirement as well as their own. Contributions are made to a SEP-IRA account. SEP plans are good for business owners with few or no employees. One place where they shine is that their contribution limits are almost 10 times that of a traditional IRA. So as a small business owner you are encouraged to¬†really save for your own (and your employees’) retirement.

Like the traditional IRA, contributions are tax deductible. Unfortunately, there is not a Roth version of a SEP-IRA available.

401(k)

A 401(k) is an employer-sponsored retirement plan. This is not some account you would go an open on your own, in fact, you can’t. It is only for small and large business that want a retirement plan for their employees (although it is possible for a business with just one employee to open one as well). Interesting fun fact, it is called a “401(k)” after the section of tax code that governs them.

It’s important to point out that a 401(k) is not an investment, it is just an account from where you can purchase various funds. For example, an employer might have Fidelity manage their 401(k) plan. That means each employee that enrolls in their company’s plan will be able to purchase funds/securities that are available to that plan.

Many 401(k) plans offer an incentive to employees to encourage them to contribute. For example, a company might offer dollar-for-dollar matching up to 5% of the employees paycheck. It is generally agreed upon in the personal finance world that if your company offers a matching program, TAKE ADVANTAGE OF IT! It is literally free money. You won’t find an better guaranteed return on investment than that!

Contributions to 401(k) accounts are capped at $18,500 for 2018, unless you’re over 50 where it is capped at $24,500 so you can make “catch up” contributions.

401(k) Tax Implications

Like with IRAs, there are Roth 401(k) accounts and Traditional 401(k) accounts. Thankfully, they are governed by the same law. Contributions to traditional 401(k) accounts are tax deductible, but grow tax-deferred. Contributions to Roth 401(k) accounts are not tax deductible, but they grow tax-free.

403(b)

A 403(b) is a retirement plan for employees of schools, some government organizations, religious groups and some other non-profits. They are very similar to a 401(k), just for non-profit groups instead of companies. An organization using a 403(b) will contract with a company to run and manage the plan.

Contributions are capped at $18,500 for 2018. They also have some catch up provisions for employees over 50 and for a few other conditions.

RRSP (Registered Retirement Savings Plan, Canada)

A popular retirement account for our neighbors to our north is the RRSP. This is a special type of tax-deferred account from which you can buy investments like mutual funds, ETFs, stocks and/or bonds. It is very similar to a traditional IRA in that investments in the account grow tax-deferred and you can receive tax deductions on your contributions (up to a limit).

When To Plan For Retirement

As young as you might be, it really is never too early to start thinking about retirement. (Ok, well I suppose if you are still a kid, then you probably don’t need to think about retirement yet.) Time in the market has a huge impact on the overall potential for your investments to grow. It is much better to start investing a little early, then trying to wait until later with larger “make up” contributions.

I also want to emphasize that none of the accounts I covered today are investments in and of themselves. They are accounts from which you can buy and sell various investments like mutual funds, stocks or bonds. If you want a little more reading on investing check out our article on DIY investing.

We’d like to hear from you. Did we miss an important retirement account type here? Do you have a favorite retirement account type or retirement strategy you found particularly powerful? If so, reach out in our comments below!

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4 comments on “Retirement Account Planning… 401k, IRA’s and Other Options

  • Why not go a bit deeper than “101” and include a tool like a “Defined Benefit Plan”… which is far more powerful for building a retirement portfolio than an IRA, a ROTH IRA, a SEP IRA and, potentially, a 401k? Granted, a Defined Benefit Plan is more challenging to create and applies only to closely held corporations (C-Corp, S-Corp, LLC, etc.), but the benefits are immense.

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