Written By: Rithwik Mathur
As young adults we endlessly hear about planning out our life and future. Lately, I bet the talk is mostly about college and applying for student loans. However, today let’s talk about retirement. What exactly is a retirement account? What are the different types of accounts? Even though the majority of us won’t be retiring anytime soon we should still have some knowledge about how retirement works. There have been many instances where we hear “savings after retirement” either in commercials for a financial advisor or a retirement plan through a company. This article aims to show the importance of retirement funds and accounts and an explanation of the two main types. There are so many options for retirement accounts and it can be a little confusing sometimes. We won't go into every specific detail, nonetheless, by the end of this piece you will have a good understanding of the two main types of accounts: 401(k) and IRA.
We all know saving is important but why? More than one in five (21 percent) don’t save any of their annual income. This is a significant issue as the goal should be to not have to work to make a living and live successful lives when retired. Additionally, this shows the number of people that live paycheck to paycheck. 40% of Americans can't cover a $400 emergency expense. Although understandable this is still an issue in itself. What lifestyle changes/modifications can we make in order to be ready to face emergencies? What do you think we can do to be ready for retirement?
Retirement by definition is “withdraw from one's position or occupation or from active working life.” Essentially, a time in your life when you feel like there is no reason to work. Specifically, from a financial point of view. Retirement and the term “financial independence” are often used interchangeably. Retirement is achieved when you have sources of income that do not have to be earned by working. These funds are typically in certain accounts that one creates during their time of work. It’s important to know about these accounts and set them up in order to have a smooth and comfortable life after retirement.
Many of you have heard of 401(k). Most likely you heard your parents talk about it while they were talking about work “stuff”. You see 401(k) plans are through an employer as opposed to an IRA which is an independent retirement account. When employers want to give employees a tax-advantaged way to save for retirement, they offer a 401(k) plan. Essentially employers allow their employees to contribute a portion of their income to a 401(k) account, furthermore, employers match a percentage of the contributions made to the 401(k) account. Contributions to your 401(k) account are made pre tax. Wow this seems pretty nice! Contributions compound tax free. Withdrawing from this account is taxed normally, however, these must be made after the age of 59 ½ or older. Again, this is all about investing in your future for long-term financial stability.
An IRA at its base is an account an individual person can set up. This retirement savings account is tax-deferred. Which means a taxpayer can delay paying taxes to some future period. This allows for much flexibility. These accounts are controlled by banks or brokerages. Fun fact: IRA’s allow account holders to own many different types of assets within the account. For example, stocks, bonds, and even real estate. These accounts are typically made for and used most commonly by small business owners and self employed individuals. These types of accounts provide similar opportunities as a 401(k) account to those without employers.
For further research into these two accounts and their various types I’d suggest reading this ARTICLE Which effectively answered the many questions I had about retirement accounts. Clearly, it's way more complicated than just putting “money aside” for old age. For those of you that know exactly what profession you will pursue, I suggest that you dive into figuring out how a person of the profession you want to pursue would set up their retirement account. Here’s a video to use as a base. Again, I am aware retirement is far from us, however, this information is good to keep in the back of the head so you are ready when the time comes and you can make the best decisions for yourself.
Works Cited
Anspach, Dana. “What Is Retirement?” The Balance, The Balance, 8 May 2019, www.thebalance.com/what-is-retirement-2388822.“IRA vs. 401k.” Ubiquity, www.myubiquity.com/401k/ira-vs-401k/.
Prinzel, Yolander. “401(k) Vs. IRA: What's the Difference?” Investopedia, Investopedia, 5 Feb. 2020, www.investopedia.com/ask/answers/12/401k.asp.
Yochim, Dayana. “IRA vs. 401(k): How to Choose.” NerdWallet, 5 Feb. 2020, www.nerdwallet.com/article/investing/ira-vs-401k-retirement-accounts.
kathleen_elk. “Here's How Many Working Americans Aren't Saving Any Money for Retirement or Emergencies at All.” CNBC, CNBC, 14 Mar. 2019, www.cnbc.com/2019/03/14/heres-how-many-americans-are-not-saving-any-money-for-emergencies-or-retirement-at-all.html.
This was very interesting and I learned a lot.
ReplyDeleteI liked your article a lot Rithwik, but I think you played your cards a little to conservatively. While it is important to have background knowledge on different retirement accounts right know, I would take it one step further and encourage anyone who has a job to open up a Roth IRA account. The only difference between a Roth IRA and a regular IRA is that the Roth gets taxed when you put money in, and not taxed when you withdraw. This is a massive advantage because since we are teenagers, we make very little money in part time jobs and therefore are in one of the lowest tax brackets. The reason why you want to start investing in a Roth IRA right now is because then your investment has more time to gain interest, and since interest is compound, it will grow exponentially. Again great post, but now is not the time for contemplation, now is the time for action!
ReplyDeleteThis was an interesting read! Many teenagers don't realize the opportunity they have to start investing in their retirement... because of the magic of compound interest, investing early means a much greater return. Anyone can open a roth IRA and start throwing money in there and create a passive income for themselves as it grows. Thanks for sharing!
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