Retirement Accounts 101
At the beginning of my third year teaching elementary school, I got an email from our Human Resources team that it was time to elect my benefits for the upcoming year. My co-worker asked me what percentage of my salary I was going to put into my 403b that year as she was considering her budget and options.
Percentage of my salary? 403b? Thinking about retiring even though I’m only 25 years old?
I had no idea what she meant. I vaguely knew I had a retirement account, but I had no idea what a retirement account actually was, what I was contributing, or how it would support me later in life. I always felt like, well, I have a savings account, so I’ll just keep saving and…have a lot of savings!
Ugh. No.
My co-worker kindly helped me navigate retrieving my lost login information for our retirement account’s homepage and uncovering a retirement account with over $10,000 in it.
This is certainly a story of privilege (I basically happened upon $10K, poor me!), but also one of serious ignorance. For the first three years of my job, my retirement account had been steadily growing (and honestly not nearly as much as it could have been) and I had literally no idea what was in it let alone how to access it.
Part of this is a systemic issue: in my experience, and certainly in my profession, we are simply not taught the basics about retirement accounts or why we should be actively contributing to them ASAP!
But another part of this is a deep-rooted issue of my own fears, which I think many women share: I really felt like understanding money wasn’t something I was supposed to do or care about. It was boring. It was for greedy people. It was for men. Good people don’t care about money, I thought. Nice people don’t care about money. As a result, I never asked questions about important-ass things like WTF IS A RETIREMENT ACCOUNT. This is not about being a nice or good person. It’s literally about setting yourself up to be financially stable when you get older.
So let’s talk about this.
What is a retirement account?
The minute details of retirement accounts can be confusing and convoluted. If you’re reading this post, I’m assuming it’s because you want to know some of the basics about retirement accounts. For that reason, much of what I’m going to share will be simplified and hopefully easy to digest. This isn’t the FULL picture, but this is a general overview of what’s goin’ on in the retirement plan world as I understand it:
A retirement account, simply put, is a pot of money that sits and grows over time and exists for you to use in your…you guessed it…retirement! This account grows over time because it’s invested (in stocks, bonds, mutual funds, etc., whatever) and you contribute a little bit (or a lot bit) each month.
What are the different types of retirement accounts?
There are a lot of different types of retirement accounts. We’re just here to cover the basics of the most common types. For the purposes of this overview, we’re just talking about two general types of retirement accounts: pre-tax and post-tax.
Before we dive into some of the details, I want to give a disclaimer that I am NOT a financial advisor, I have no formal training in this space, and I am not authorized to give you actual advice on how to manage your finances. I am literally a woman who realized she didn’t have her financial sh*t together, who felt systemically kept in the dark about money, and who is trying to learn as best she can how to get out of the dark and connect/share with other women along the way.
401k/403b/traditional IRA aka the pre-tax dollar retirement accounts
For all intents and purposes, these types of accounts are the same. The main difference is that 403b plans are offered by non-profits, religious groups, schools, and government organizations.
With all these plans, you put pre-tax money (money that has NOT been taxed yet) into your retirement account. This is different from a regular, taxable investing account where you are first taxed on the money and then taxed again when that money makes money throughout time.
For example, if you make $100 and it gets taxed, you might be left with ~$85 (depends on the tax rate). In a 401k or 403b, you would get to invest the entire $100. Once you contribute, your money will go into an investing account where a professional investing company manages it. Your money will get taxed eventually, but not until you retire and begin to withdraw it. The maximum amount you can contribute to this type of account each year is currently $19,000.
Despite having to pay taxes on this money later, this account still provides huge benefits because your untaxed money gets to compound and grow over time. This type of account makes the most sense for someone who predicts they’ll be in a lower tax bracket when they retire than where they’re currently at (and thus would be paying less in taxes later rather than paying them now).
One other major potential benefit of a 401k or a 403b is that your employer might offer matching up to a certain percentage. Simply put, this means if you put $100 in your account, your employer will also put $100 in your account. THIS IS FREE MONEY. If your employer offers this benefit, get on that asap. A.S.A.P. Like, right when you finish reading this.
If you don’t have an employer or your employer doesn’t offer a retirement account, you might consider setting up an Independent Retirement Account (IRA). In these accounts, the maximum you can contribute for the year is $6000 and you won’t be taxed on your investment gains (when your money makes money, it won’t get taxed). Like a 403b or 401k, in a traditional IRA account, you put pre-tax dollars in and you’ll be taxed when you retire and start withdrawing the money.
The downside of the above mentioned accounts is that you’ll be charged a big penalty (10%) if you withdraw your money before retirement age at 59.5 (though there are some exceptions to this rule, like if you’re buying a house). Overall, though, these accounts are for retirement and you should consider the money gone until you retire.
Roth-IRA aka the post-tax dollar retirement account
In this type of account, you invest money that you’ve already paid taxes on. When you withdraw the money in retirement, though, you don’t owe anything. If you invested $100 that you already paid tax on in 2019 and withdrew it in 30 years later, you’d have ~$800 that you wouldn’t have to pay taxes on (using bigger numbers, if you invested $50,000 post-tax dollars into your Roth IRA and withdrew it 30 years later, you could expect to have ~$400,000 that you wouldn’t have to pay taxes on). That’s a pretty good deal.
As with most retirement accounts, though, you’ll get penalized if you withdraw your earnings before retirement age (the exception is that you are allowed to withdraw the amount of your initial investment with no penalty since you’ve already paid taxes on it and there are some other exceptions like buying a home or paying for education — again, you should mostly consider this money GONEZO until you retire).
These accounts seem to make most sense for people who think they’ll be in a higher tax bracket when they retire.
How do I choose?
Honestly, I’m still grappling with some of this myself. I currently have a 403b through my employer and am strongly considering also opening a Roth IRA because, from what I understand, though these accounts work differently (pre-tax vs. post-tax), there are tremendous benefits to each and it’s overall a good idea to max out on the amount you can contribute to retirement.
Instead of getting into the weeds of which plan to choose, start by making sure you:
a) Are signed up for some sort of retirement plan
b) Are maxing out your contributions towards your retirement plan
Where should I go from here?
Go figure out which type of retirement account you have. If you don’t have an account and you have an employer, set up a phone call with HR for tomorrow morning and figure out which type of plan your employer offers and then get enrolled as soon as you can. If they offer matching, take advantage of it (this is one thing I’m super clear on so I want to say it again: if your employer offers matching, do NOT miss out on that opportunity).
If you don’t have an employer, start doing your research and set up an IRA.
Similar to our conversations on the stock market, the way to win the retirement account game is literally to make sure you have a retirement account and are contributing to it regularly. Even $50-$100 a month makes a huge difference because of compounding (your money grows exponentially, over time, when it’s invested). Every dollar you invest now is going to be worth a hell of a lot more in the future. The sooner you start investing dollars, the better.
TLDR!
We talked about 2 types of accounts:
- Pre-tax (401k, 403b, and Traditional IRA)
Benefits
· You put money in before you’ve paid taxes on it and it grows tax free
· Potential for employer matching (free $$, people!)
Downsides
· You have to pay taxes on the money eventually (when you retire)
· Big penalty for withdrawing money before retirement age (59.5) with a few exceptions — you should not expect to touch this money for a very long time
2. Post-tax (Roth IRA)
· You don’t have to pay taxes on the money when you retire — it grows tax free and you withdraw the money tax free
Downsides
· You have to pay taxes on the money before you invest it
· Big penalty for withdrawing earnings before retirement (though you can withdraw amount of your initial investment without penalty — again, you should plan NOT to have to touch this money until you retire)
Conclusion? Make sure you have a freaking retirement account and are regularly contributing. Every dollar you contribute today is worth a lot more dollars when you retire and having dollars when you retire is good.
