Two Retirement Accounts You Should Know About

The best time to start investing is now.

Photo by Micheile Henderson https://unsplash.com/@micheile

In August 1935, President Roosevelt signed Social Security into law. It aimed to support the elderly, infirm, or unemployed.

As a tax-payer, you contribute to Social Security with every check. Then at age 62, you can enroll in Social Security to support your retirement.

In theory, it sounds pretty good. You put some money into a pot to help others, and after a few decades, you get to grab some money from that pot.

However, the Social Security Administration estimates that Social Security will be depleted by 2035 unless the government makes some improvements. Why? Because there will be more people collecting from the pot than people putting money into it.

Investopedia suggests that people in their 40s or 50s, may not get their full Social Security benefit.

With that said, it’s a good time to start learning about other retirement options.

I’m not a certified financial advisor, so the following is not investment advice, but I’m going to introduce you to two common investment accounts that will help you plan for retirement.

401(k)

If you’re paying into Social Security and work for a company, there’s a strong chance you have access to a 401(k) plan.

A 401(k) plan is an account that you and your employer agree to contribute money to.

You can invest up to $19,500 a year without having to pay taxes until you withdrawal (tax-deferred).

The amount your employer contributes is called an employer match and the amount will vary.

Your employer’s match is considered “free money”, with quotations, because you have to meet certain requirements before you receive the employer match. You also have to be an employee for a number of years before their match vest.

Vest means that ownership of the contribution transitions to you. Your employer may require you to be an employee for three years before their match vest. Otherwise, they may take back their contribution.

The benefits of investing in a 401(k) are the following:

1. Tax benefits: If your annual salary is $60,000 and you contribute $19,500 (max) to your 401(k) plan, then $40,500 will be reported on your W-2, which will lower the amount of taxes you owe.
2. Employer match aka “free money”: As explained above, if you’re contributing to a 401(k) plan, most companies will assist you by contributing up to a percentage of your salary. Make sure you read the vesting requirements for their contribution.
3. You can take it with you: Once you choose to opt-in to a 401(k) plan with an employer, you remain the owner of the account even if you quit/get fired.
4. Easy payroll deductions: Your employer automatically deducts a percentage from your check and deposits it for you.
5. You are in control: You choose how much to contribute and, depending on your plan administrator, which stocks to select.

The disadvantages of investing in a 401(k) are the following:

1. Penalty fee: If you withdrawal from your account before you’re 59.5, you’ll pay a penalty fee on top of taxes.
2. Taxes you pay when you withdrawal: The money you withdrawal will be counted as income and could push you into a higher tax bracket. Smart Asset suggests taking distributions gradually rather than one large lump sum.
3. Your investment choices may be limited. Your plan administrator might lock you into certain investment accounts that offer a safe return, which could be good or bad depending on your goals.
4. You pay fees to have your 401(k) plan managed: Fees vary based on plan administrator and employers, so the best thing is to review your employer’s plan summary or work with a financial advisor / HR to understand the fees.

How to open a 401(k) plan?

1. Choose to opt-in a 401(k) plan when you start a new job and enroll in benefits.
2. You can also choose to opt-in at the next open enrollment for your employer (check with HR).
3. If you’re self-employed or a small business owner, you can open an Individual 401(k) plan with companies like Schwab that offer low fees.

Individual Retirement Account (IRA)

As the median amounts in this study show, millions of Americans over the age of 55 have too little saved for a comfortable retirement, and not enough time to save significantly more — David John / CNBC

An IRA is an individual account that you can open if you have taxable (earned) income.

Why do you need another investment option? Because the challenge with retirement, other than medical issues, is not having enough money saved up to support 20–30 years without a full-time job.

That’s when an IRA steps in to help.

With an IRA, you can invest up to $6,000 / year and $7,000 / year if you’re over 50 and have access to more investment options.

There are two types of IRA accounts:

1. Traditional IRA: a tax-deferred account like 401(k) plans. You can contribute to an IRA throughout your whole life but will need to start withdrawal at 70 years old.
2. Roth IRA: a non tax-deferred account where you deposit taxed dollars and can withdrawal at any moment without penalty. For example, if you invest $500 from your paycheck (taxed) and it grows to $2500 over four years, you will not have to pay taxes again if you withdraw, let’s say, $150.

Benefits of an IRA:

1. You have access to more portfolio options.
2. Traditional IRA: You can rollover multiple 401(k) plans into one account to manage.
3. Tradition IRA: You can withdrawal up to $10,000 — $20,000 for couples — without penalty to buy, build, or rebuild a first home.
4. Roth IRA: You don’t pay income tax on investment gains.
5. Roth IRA: You avoid taxes in retirement.

Disadvantages of an IRA:

1. No employer match
2. You have to make contributions before April 15th: https://www.irs.gov/retirement-plans/ira-year-end-reminders
3. Contribution limit of $6,000 per year or $7,000 if you’re over 50.
4. You have to have earned income to invest in either IRA account.
5. Traditional IRAs have early withdrawal penalties. (Roth IRAs do not)
6. Traditional IRAs require you to withdrawal once you turn 70.5 years old.
7. Roth IRAs require you to pay taxes upfront (could be bad or good)

How to open an IRA account?

1. An easy option is a bank or financial institution like CapitalOne and Fidelity.
2. Online options like Webull

How much should you invest in your 401(k) and IRA accounts

The best place to start is with a budget so you can identify your monthly net total (income minus expenses).

4 Easy Steps to Start Budgeting and Saving Money

You can use apps like Mint or Quickbooks to automatically track your spending or do it manually with a spreadsheet.

I recommend using an application like Quickbooks because it’ll make it easier to track and review at the end of each month.

Once you have your net total, determine your risk level by filling out this 8 question survey from Brightstart.

When I took the survey, I scored a Moderate level, which helps me understand that I would be more comfortable with mature stocks like J.P. Morgan instead of meme stocks like GameStop.

Now that you figured out your net total and risk tolerance, you might probably be wondering how your 401(k) plan and IRA account make you money.

My risk level result from brightstart

Your Retirement Accounts and Stocks

The money you invest in a 401(k) plan or IRA account gets invested into a portfolio of stocks.

The amount of stocks you own for each company is called a share.

The value of a share will fluctuate based on how well a company performs and how well people perceive it to be performing (psychology).

Therefore, the rate at which your retirement savings grows depends on how much you contribute and how well you pick your investments.

If you don’t want to study stocks, you can choose to let your plan administrator manage your account for you.

Your plan administrator will probably pick a target-date fund, which will start with aggressive investments when you’re young and automatically moves into more conservative investments as you near retirement.

However, if you’re interested in learning more about retirement accounts and the stock market, here are my suggestions:

1. The Balance is a website that writes about Budgeting, Banks, Retirement, and more. They write in a way that’s easy to understand and welcoming to beginners.
2. Investopedia is a website that breakdowns accounting terms provide news and training. It’s my go-to place for a brief and concise explanation.
3. Pensionless Retirement is a short read that describes ten steps to plan for retirement.
4. The Only Investment Guide You’ll Ever Need dives deep into investment accounts and stocks.

Final Thoughts

The best time to start investing is now.

If you’re young, you have many years before retirement, and you can make aggressive investments in hopes for greater return.

If you’re over 50, you can invest more conservatively and make catch-up contributions to both your 401(k) plan ($6,500 / year) and IRA account ($7,000).

Even you can only save $10,000 by the time you retire, that’s still $10,000 that you, otherwise, wouldn’t have had.

As my professor used to say, half a loaf is better than no loaf.

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