Hey, welcome back! So in the last two lessons you learned all about Social Security,
Pensions, and Annuities and those are all great sources of retirement income,
but they're not really designed to fully replace your income. You definitely don't want to just
rely on those to support yourself and cover your financial needs when you go into retirement.
Which brings us back to the idea of investing and making your money grow over time. There
are plenty of different retirement accounts that you could invest your money into. You
have the 401K, the 403b, the IRA, the Roth 401k, the Roth 403b, the Roth IRA.
Alphabet soup, am I right? Don't worry, I promise you this all looks a lot worse than it actually
is and by the end of these next two lessons, you will not only know all about investing into these
different accounts but you'll also know which one is the best for you. Let's get into it!
The retirement accounts that we're going to start talking about are all investment accounts.
So unlike Social Security, Pensions, or Annuities, you get to choose how much you want to contribute
and to what kind of fund you contribute to in order to save and make your money grow over
time. Just like with any other investment, there are risks associated with this but don't forget
our investing lessons. You can lower your overall risk by diversifying your investments, investing
in the long term, and doing your research. All of this advice still applies here. Like I said at
the start, there are plenty of different kinds of retirement accounts that you can choose to invest
in. So I've taken all the most popular types and split them into two different categories based on
one very important thing; when you pay your taxes on your money. The first group we'll be talking
about today will be called pre-tax retirement accounts. They're called free tax because with
these types of investments you contribute money into your account automatically from your paycheck
before taxes have been taken out of it. This lowers your taxable income potentially putting
you in a lower tax bracket with lower taxes. More money now! But when you retire and you're
ready to start using the money from your account, you'll then have to pay taxes on every withdrawal.
These accounts are often called tax deferred since you put off paying these taxes until a later time.
The other group will be called post-tax retirement accounts. These are called post-tax because
here you also contribute money into your account automatically with every paycheck,
but this time it's after you've already paid your taxes on your money. This increases your
taxable income potentially putting you into a higher tax bracket causing you to pay more
tax now. That sounds bad, right? Well maybe for now but when it comes time to retire and
you're ready to start using the money from your account, all that money goes straight
to you because you've already paid taxes on it. So enjoy your time at the beach retiree!
The three types of retirement accounts we're going to be talking about today are all the
most popular kinds of pre-tax retirement accounts that you can get. They are the
traditional 401K, the traditional 403b, and the traditional individual retirement accounts,
or IRA. Let's start with the 401K. The 401K is a retirement savings plan that
many employers of private for-profit companies offer their employees.
With a 401k you automatically contribute to the account with each paycheck you receive and
your employer will offer a pool of investment options that you can choose from to invest in.
The contribution limits change every year because the cost of living changes, but for the year 2023
you can contribute up to $22,500, or up to $30,000 if you're over the age of 50. What's nice about a
401k is that many employers will offer an employer match meaning that for every dollar you contribute
to the account, your employer will contribute the same amount but usually up to a certain point. If
your employer offers you employer match on a 401K you should take it. That's basically free money!
Now remember this is a retirement account. It's for when you retire not for when you blow
through all your savings. The IRS allows you to withdraw money from your 401k penalty free only
when you hit 59 and a half years of age. These withdrawals are called qualified distributions.
Actually the IRS requires that you start withdrawing money from the account when
you hit the age of 72. Then these withdrawals are called required minimum distributions,
but let's say that you want to withdraw some of that money early before you're 59 and a half.
Well then you're going to need to pay an early withdrawal fee which is usually at least 10% of
the money you're withdrawing. There are some exemptions to this like if you're using that
money to buy your first house, pay for higher education, pay for medical bills, and a few other
things but generally if your withdrawal doesn't meet the exemption requirements, that 10% is a
big chunk of change that you're losing out on. All in all, if your employer offers you a 401K with
employer match, this is definitely an account that you're going to want to consider investing in.
Next up is the 403b. The 403b is a retirement savings plan available to employees of non-profits
and tax-exempt organizations. So a lot of Public School employees like teachers and librarians,
medical professionals like nurses and doctors, government employees, and clergy can invest
in a 403b. Aside from the type of employment requirements that you need to actually receive
the accounts, a 403b basically works exactly the same as a 401k. It's a pre-tax retirement account,
it has contribution limits of $22,500 a year or $30,000 a year if you're over the
age of 50 for the year 2023, it could also come with an employer match but I will say
that this feature is less popular with the 403b than it is with the 401K. Uh,
the 403b has the same qualified distribution and required minimum distribution requirements as the
401K and it also has that same early withdrawal penalty of 10%. So all in all if you are offered
a 403b with employer match then that is definitely an account that you're going to want to consider.
And lastly we have the traditional Individual Retirement Account, or IRA.
The word individual in the name of this account leads to the main difference between the IRA and
the 401K or 403b. An IRA is an account that is set up by the individual and not sponsored
by the employer like the others. Because an IRA is not an employer retirement account,
you won't ever be getting an employer match on your contributions. And unlike a 401k you
won't have a pool of Investments to choose from but rather you'd have complete control over what
you want to choose to invest in. There are contribution limits in an IRA and they're
lower than that of a 401k or 403b. For 2023, you can contribute up to $6,500 a year or $7,500 if
you are over the age of 50. Aside from those differences, an IRA is a pre-tax retirement
account and it has those same withdrawal requirements with qualified distributions and
required minimum distributions as a 401k and 403b even with that pesky 10% early withdrawal penalty.
This type of account is great for someone who wants to invest outside of or alongside of their
employer retirement plan, or for someone who's transitioning to self-employment.
And that's about it! That's all the info you need to know on the top three most popular
pre-tax retirement accounts. The traditional 401K, traditional 403b, and traditional IRA.
I've been saying traditional a lot and that's because there is actually a Roth 401k,
a Roth 403b, and a Roth IRA. These are all post tax retirement accounts and they're exactly what
we're going to be talking about in the next video. And after that video you will know
everything you need to know to decide which of these are the best for you to invest in.
Because you don't need to pick just one, in fact there are a few good strategies that
have you investing in multiple! I'll see you in the next video!