What the heck is an IRA or 401k? Retirement accounts, IRAs, and 401ks, explained.

👀 7minute read

📷: Pinterest

The financial industry isn’t hard, it was set up to be hard. And one thing that is unnecessarily hard are the names of financial things.

Sometimes it feels like a group of kids woke up one day and said, you know what we should do? We should create code names for all of these cool investments that can help you save more money, so nobody else can play this game with us. Well, no more of that.

We’re here to ensure you can get in on this money-saving game, too.

What are these things?

401ks, IRAs and the like are retirement accounts that have tax benefits.

They are named after the tax codes that brought them about, which is why they sound like an alien language. You will never need to know why they are called what they are called, but you do need to know why they might be good for you.

They are accounts that have major tax savings, and are designed to help you save for your future.

Who wants to work forever? Ok, maybe you love your job. We hope you love your job. But regardless, you at least want the choice to stop working at some point, right? These retirement accounts, 401ks and IRAs, help you save, grow and invest so you don’t have to worry about money down the road.

Why should I have a 401k or IRA? Why now?

Major tax savings. Free money. Did someone say free?

Think of these accounts as an extension of savings accounts offered by your bank or financial institution. They make it easier for you to save and grow your money, right?

A 401k and IRA work in the same way, with extra perks.

• You either pay less taxes today (more money in your pocket) or pay less taxes later (again, more money in your pocket)
• You can buy and sell investments within the account tax-free (more money in your pocket)
• Your company may match the amount you contribute to the account (you know it, more money in your pocket)

Most people dismiss retirement accounts, thinking you can wait to start until you’re older and wiser. Here’s the thing: The earlier you start, the more you can make. You can make more money by putting away a small amount today – than if you wait for that bigger paycheck when you’re 40. Seems counter-intuitive, but it’s how the math works. 

No, seriously. Let’s talk numbers for a second. If you start to invest $3K per year when you’re 22, you could have $750K at 65.

SEVEN HUNDRED AND FIFTY THOUSAND!

Yes, you read that right. And thats with $300 a month for a year. Magic!

P.S. Access to this calculator is available in our handy app.

When you set up one (or more) of these retirement accounts, it means you can keep even more of your money for future you to enjoy. Win, win, win.

Are your eyes glazing over? We know... it is impossible to teach this via a blog. That's why we built Penny Finance. Our app shows you how, instead. Because, how can you actually apply this info to your ever-changing life?

Phew, Show me how plz

If you are into this and can learn this way, keep reading!!!

What is the difference between a 401k and an IRA?

They are both retirement accounts. They both have tax benefits. They are both great for saving and investing. They both can’t be touched until you are ~60.

The difference is in who set it up. A 401k was set up 4 you. An IRA was set up by you.
Did you set it up or did your company set it up for you?

IRA: Individual Retirement Account

There are two types of IRA accounts: Roth IRA and Traditional IRA.

Both are accounts you can set up on your own. Both offer you more ownership, options and flexibility on how you want to invest your money compared to a 401k.

The main difference is whether you pay less taxes today (Traditional IRA) or less taxes later (Roth IRA).

If you’re on the fence about which account to open, get both!

You can contribute to both a Roth IRA and a Traditional IRA, for a maximum of $6,000 combined if you’re under 50. Even if you start investing only $100 into each, you really can’t go wrong.

401k: Money 4 You

If your company set up a retirement account for you, you probably have a 401k. These accounts are named after the tax codes that brought them about. You might feel like there’s a million different accounts that start with 4, but remember – if it starts with 4, it’s a benefit 4 you. Easy, right?

The biggest benefit for the 401k compared to IRAs? More money, more savings.

You have a much higher contribution margin: you can deposit up to $19,500 per year in a 401k. More money invested means extra money for you to enjoy in the future.

• Your employer may top-up your contributions AKA match (double the money = more money in your pocket)
• You have a higher contribution limit (more money invested = more money in your pocket)
• You pay less taxes today (you guessed it – more money in your pocket)

At this point, you might be wondering why anyone would get an IRA if the 401k is so great.

More benefits, more rules. There are limitations around what you can invest in. If you were excited about investing on your own at your favorite bank, the 401k won’t give you that choice. You’ll have a menu of investment options, and you’ll need to stick with the bank your company picked. At first glance, this feels like a downer. What happened to your money, your rules, right? 

In reality, the 401k still wins. Having a menu to choose from makes investing much easier. And these menu options aren’t just picked at random – they are carefully curated to give you the best bang for your buck. Instead of trying to figure out which investment options are better in an IRA, you can pick from a curated menu of choices in the 401k and focus on saving money (and time, cuz someone else already did the homework for you!) 

Can I have both? Do I need to choose?

Yep. You can have the cake and eat it, too. You can have both a 401k and an IRA, and contribute money to both within the same year. That being said, there are rules around how much money you can add to these accounts and limits on how much you can invest and/or withdraw later. If you’re not ready to dive in, the easiest way to start is one step at a time. Open one account. Get the hang of it. Open more later. Your 50-year-old self will be grateful you did.

What if I have an account that isn’t a 401k or IRA, but I think it’s a retirement account?

Totally possible! If you work for the government or for a school, you might have a 403b or 457. Again, if it starts with a 4, it’s a benefit 4 you. If you work for a small business or entrepreneur you might have a SEP IRA. Also great.  All of these accounts provide amazing savings and tax advantages.

Money tip: If your account statement just says your name on it, like “Jane Smith” and / or you can withdraw money without any *major* warnings that you are about to “distribute” or incur tax bill – then it isn’t a retirement account.

What if I don’t have an account, which type of retirement account is best for me?

If your employer offers a plan, start there. They can help set up a 401k or similar account 4 you, and even match your contributions.

Time for a video break ya? We walk through a 401k to find the perks!

If your employer doesn’t offer a plan, you have 2 options: a traditional IRA or a Roth IRA. Generally speaking, you can’t go wrong with either. If you are 20 to 30 years old, a Roth IRA will most likely have the greatest financial benefit.

However, without going through your full situation (your age, your tax bracket, your salary, your employment status) it is hard to make a blanket recommendation.

There’s no one-size-fits-all recommendation to finances. And there shouldn’t be. You have goals and dreams you want to achieve. Your money matters. And you need a financial plan that is personalized to you. Not a blanket recommendation that may or may not help you save more.

That is why we made Penny. Our intelligent calculators will determine the best option for you, with you, powered by you.

Start investing in yourself today.

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• retirement