Basic Investing Terms GenY Should Know: Part 2
If you were here last week, you already know that I’m aware of just how confusing the financial world can be. The fancy lingo, the 50-page reports and the constant chatter about “what the market is doing” can make you feel overwhelmed, out of the loop, or just plain put you to sleep.
That’s why I decided to take two weeks to dig into some investing basics and make sure that you feel comfortable with the terms and issues you may be confronted with in your financial life. And of course, my aim is to do this in a way that intrigues rather than bores.
If you missed last week’s post on Investing Terms GenY Should Know: Part 1, feel free to review it before diving in here. This week, we’ll jump into retirement account types to ensure you understand the ways in which you’re stocking away money for your future self.
Note: For the accounts below, you have to have earned income in order to contribute. Your IRA and Roth IRAs will be self managed at a custodian of your choosing while your 401(k) is an employer sponsored retirement plan.
Traditional Individual Retirement Account (IRA):
An IRA allows you to contribute pretax income (up to a certain threshold) to an investment account, which can grow tax-deferred, meaning you pay no taxes on principal (contributions) and earnings until funds are withdrawn from the account. For 2014, tax-deductible contributions may be made up to $5,500 to an IRA account. Penalty free withdrawals from your IRA can begin at age 59 1/2 and become mandatory at age 70 1/2. Translation: You’re saving money on your taxes at today’s rates, but you’ll be paying a future (possibly higher) rate upon withdrawal.
Note: For 2014, your Traditional IRA contribution is only deductible if you aren’t covered by a 401(k) at work and your income is below $60,000 if you’re single or $96,000 if you are married.
Roth Individual Retirement Account (Roth IRA):
A Roth IRA is similar to the above Traditional IRA except that contributions are made with after-tax income and therefore are not tax deductible. For 2014, non-tax deductible contributions may be made up to $5,500. There is no mandatory age for withdrawal and there are no taxes due on principal or earnings upon withdrawal from the Roth IRA. Translation: You’re paying taxes upfront at today’s rates, instead of paying the (possibly higher) rates in place when you begin withdrawals.
Note: For 2014, you can contribute to a Roth IRA as long as your income is less than $114,000 if you are single or $181,000 if you are married.
A retirement account sometimes offered through an employer. The 401(k) can come with a Traditional or a Roth option depending on your employer offerings. For 2014, tax-deductible (for a Traditional) or after-tax (for a Roth) contributions can be made up to $17,500. Contributions are deducted automatically from your paycheck and for the Traditional option, funds will grow tax-deferred until withdrawal. For the Roth option, there will be no taxes on principal or earnings at withdrawal .
A 403(b) is similar to a 401(k) except this account will apply to employees public education organizations and some nonprofits.
An employer contribution to a company sponsored retirement plan, in which your employer contributes an amount to your plan equal to a specified percentage of your personal contribution. Your employer is essentially “matching” a portion of your contribution. If your employer provides a company match, you’ll typically see language similar to this in your benefits handbook: We will match 50% of your personal contribution to your 401(k) up to 6% of your salary.
Note: It is important to always take advantage of this benefit. Otherwise it is “free money” that you are leaving on the table. Taking advantage will require you to contribute a certain amount of your base pay up to a pre-set limit and the company will match your contribution with funds of their own.
When it comes to putting away money for retirement, just get started! If you have an employer match, take full advantage of the free money offered first and then take some time to review your taxes to make the decision on if the rest of your retirement savings should be put towards a Roth IRA or 401(k). If you have a low income now and don’t need the tax savings, go ahead and max out your Roth IRA if possible. If you’re in a high income tax bracket and could use the tax savings, consider maxing out your 401(k) to ease your tax strain.
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