Demystifying your 401(k), IRA, and Roth IRA

With so many options and so much noise when looking at different retirement programs let’s take a look at demystifying the three of the most common types of retirement accounts. Not so fun facts: According to Northwestern Mutual 1 in 3 Americans have less than $5,000 in retirement savings with one in five having no retirement savings what-so-ever.  Most advisors will recommend that during retirement you will need seventy to eighty percent of our preretirement earnings to maintain our current way of life before entering into retirement. The largest consideration of that number is if you have your home paid for or not. To avoid working, literally, for the rest of your life it is important to know where you can put your money to help you prepare for the golden years ahead.  

Traditional 401(k):

Photo by Anukrati Omar on Unsplash

The most popular form is a “defined contribution” retirement plan, more generally speaking this is a retirement plan where the employee, employer, and or both parties contribute a specific percentage or dollar amount of their income towards the employee’s retirement. Contributions are excluded from the employee’s gross income on a pre-tax basis, that is before taxes are accounted for on your check, and grow tax deferred until the funds are withdrawn during retirement, so you do not pay taxes on the money until you start collecting your retirement.

This should be the first place that you place your money when this option is available to you as part of your employer’s benefits, plus you will have the money come directly out of your paycheck and that is making savings automatic and easy for you.  On top of that, most employers offer a match of a certain percentage of your income and you should always contribute enough to participate in the full match. Let’s repeat that, if you are not able to contribute the maximum amount to your 401(k), contribute at least the amount that your employer is matching. If you are not participating to the full match you are giving up free money. For example, if you are making $48,000 per year and your employer matches 3% per check, getting paid twice a month at $2000, your employer is giving you $1,440 per year as long as you are putting at least that much in your 401(k) as well. Over time those funds will compound and grow.

For the 2020 tax year the IRS limits of contributions to your 401(k) plan are capped at $19,500 and $26,000 for those 50. The difference over 50 is called catch-up contributions, and regardless of how much you have saved, that limit is available for all individuals over 50 participating in their employer’s 401(k) plan. It’s important to remember that even a little bit of savings helps and if your employer is offering a 401(k) plan, participate.


IRAs were made to encourage individuals with earned income to save for retirement in addition to other retirement plans they have. Also known as traditional IRA accounts, all deposits made to your IRA are made on a pre-tax basis and grow tax deferred until the funds are withdrawn during retirement, age 59 ½ or older, similar to that of your traditional 401(k) plan. The funds placed into an IRA account are still available to you should you not wait to retire however, there is a ten percent additional tax penalty for early withdrawal prior to age 59 ½ with a few exceptions.

Photo by Austin Distel on Unsplash

For the 2020 tax year the IRS limits of contributions to your IRA are capped at $6,000 or the amount equal to your taxable compensation for the year if less than $6,000. However if you are age 50 or older you are eligible to add an additional $1,000 “catch-up” deposit to your annual contributions. The good news is this year as of the 2020 tax year, there is no longer an age limit on making contributions to your IRA as long as you are still having earned income, however you must begin taking minimum required distributions the calendar year in which you turn 70 1/2, you are born before July 1, 1949 and 72 ½, if you are born after June 30, 1949.

There are several different choices in investment vehicles within your IRA depending on what type of account you opened and your risk profile. Most banks and investment institutions have basic IRA savings accounts or CD’s where your retirement money can sit in FDIC insured accounts or brokerage accounts that will allow you to invest. Whichever way you choose is right for you, but please seek the advice of a professional and educate yourself in your choices.

Roth IRA:

A Roth IRA allows the same contributions amounts as the traditional IRA. The total maximum amount that you can deposit to your IRAs, traditional and Roth is capped at $6,000 and $7,000 for those 50 and older total combined.  

The difference between the two comes in the timing of the tax benefits. Opposed to the traditional IRA pre-tax dollars that lower your taxable income this year growing tax deferred, the Roth IRA is funded with post taxed dollars that are not taxed at the time of withdrawal during retirement.

Roth IRAs have no required minimum distribution at any age at this time, but there are limits to the income that you make to if you can contribute. The income eligibility as of the 2020 tax year if single, head of house has income limits of less than $124,000 and if married filing jointly less than $196,000. This is a great vehicle for your money as well when saving for retirement, especially if you believe that your taxes will increase in your retirement years.

Not one or all of these are created to be your only tool for retirement, remember saving now will allow you to enjoy retirement latter. Saving as much as you can now will give your funds more time to grow, taking advantage of compounding interest and market growth.

Regardless of your approach, tell me how it is going and let’s start a better money discussion. 

3 thoughts on “Demystifying your 401(k), IRA, and Roth IRA

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.