McDuck, Scrooge / Disney
Markets took a nose-dive in mid-March, erasing their entire gains since late 2016. Now, however, they’ve begun showing signs of a resurgence and now is just a good a time as any to revisit the contributions you’re making to your retirement funds (or to start if you haven’t been doing so).
However, before you think about investing, make sure you have plenty of cash set aside to hold you over during this rough economic period. Many have lost their jobs, and the unemployment rate is forecast to continue rising, through 3Q 2020, so it never hurts to prepare for the worst, i.e., having an emergency fund (6-9 months’ worth of living expenses is a good rule of thumb) .
So assuming you have an emergency fund and are able to set aside money for retirement every month, here’s some basic information on retirement accounts that should help you get started.
IRA vs 401(k)
Both an IRA and a 401(k) are types of retirement savings accounts that carry with them certain tax advantages. You’d likely get the former if you’re self-employed, and they’re typically offered by most banks, while the latter is offered by employers as part of your benefits package. There are limits to how much you can contribute to each account depending on whether you’re single or married, and if you’re under or over the age of 50.
An employee can contribute up to $19,500 (in 2020) to a 401(k), while individuals can contribute a maximum of $6,000 to an IRA.
Traditional vs Roth - IRA
There are two types of retirement accounts under both the IRA and 401(k) categories- Roth and traditional. The main differences between the two are when you get taxed- either when you make contributions to your account or when you make withdrawals.
With traditional IRAs, your contributions are tax deductible, but you have to wait until age 59 1/2 before you can make penalty-free withdrawals. Contributions to Roth IRAs on the other hand, are not tax deductible but you can withdraw whenever you want without incurring taxes or penalties. It’s important to note though that the IRS does have income limits- meaning you can’t contribute to a Roth IRA if your income is too high.
Traditional vs Roth - 401(k)
401(k)s- employer-sponsored retirement plans- are nice and can be great if your employer matches some or all of your contribution. The differences between tradtional and Roth 401(k)s are similar to those of IRAs. Traditional contributions are made pre-tax, meaning they’re also tax deductible. However once you’re able to begin withdrawing at age 59 1/2, you will be taxed at ordinary income tax rates. You would opt for traditional if you expect your income tax rate to be lower at retirement than it is now. Contribution limits are $19,500 if you’re under 50 and $26,000 if you’re over 50, and these do not include company matches.
Roth 401(k)s, on the other hand, are funded with after-tax dollars. The benefit, though, is that your’e not taxed when you make withdrawals. You would opt for a Roth 401(k) if you expect your income tax rate to be higher when you’re of retirement age.
So that’s it. This was meant to clarify the basics of retirement accounts and to get you making contributions now while the markets are “on sale.” If you have more questions or need further guidance, I’d strongly recommend speaking with your financial advisor and/or HR representative who can better explain the specific plans your company offers.