Retirement accounts: IRAs and 401ks
401(k)s 401(k)s (and how they compare to IRAs)
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- What I want to do with this video
- is to talk a little bit about 401(k)s,
- Which you probably at minimum have heard of,
- and just from the get-go, just to put some structure
- in your mind of what this really is,
- is it's very similar to a traditional IRA.
- And the ways that they're the same is that you defer your taxes.
- So you put money in on a tax deferred basis,
- Let me put it this way, you put untaxed or you put
- pre-tax money in, the money can grow inside of
- either the 401(k) account or the traditional IRA account
- untaxed. Let me write that.
- Money grows in account untaxed, and then you can
- withdraw it, you can withdraw the money
- or start getting distributions from the account
- after age 59 and a half.
- So that's essentially when you're gonna start retiring,
- when you're gonna need the money.
- And when you withdraw after the age of 59 and a half,
- you will then pay income tax.
- And this is what people are talking about
- when they talk about deferring taxes,
- you're not getting out of the taxes,
- you're just pushing off the date that you're going to have to pay the taxes.
- And for a lot of people this might be useful,
- because while you are making money, you might be
- paying at a fairly high incremental tax rate,
- but then once you're retired, you'll have a much lower one
- I guess you be in a much lower incremental tax bracket
- So your total overall tax bill might be lower.
- Also maybe something happens just in terms with what the government does
- in terms of how they charge taxes.
- And in general, if you have to pay 50 cents
- 20 years in the future versus 50 cents today,
- just present value of money tells you that
- that 50 cents is going to be worth a lot less in the future,
- or the present value is a lot less.
- So that's some reason to defer, but of course,
- you're not paying, you're not just gonna pay on what you put in
- you will then also pay income tax on what you put in
- and whatever grew, so you will pay income tax on total
- on total dispersals.
- And in both cases you have to start taking despersements
- from your account by 70 and a half,
- so penalties, let me write it this way:
- penalties if you don't withdraw, or you don't
- start withdrawing some of your funds by
- 70 and a half. And there are some special cases
- if you're working and all these type of things.
- Now, what happens if you withdraw
- before age 59 and a half?
- So so far everything I've listed is true of both
- 401Ks and traditional IRAs,
- if you withdraw before 59 and a half,
- you are taxed on withdrawal and,
- on top of that, there's a
- 10% penalty on all the funds you receive.
- And this is what you have to think about
- unless you know if you just say,
- I'm just always gonna max out my traditional IRA or 401(k),
- you've gotta make sure that you're want that money
- before 59 and a half, because you might be facing
- this 10% withdrawal. So these are all the cases
- that they are the same, so the question is,
- why do they both exist? Why is there something
- called a traditional IRA, and why is there something called a 401K?
- They both seem like a pretty good way for me to
- defer taxes, get earnings on income on my investment
- in a tax deferred way and then pay at some future date,
- and they both kind of force me to make sure they
- strongly suggest that I shouldn't take out my money
- before 50 and a half. So the ways that they're different
- so let's focus on the differences,
- so the differences between the two.
- One is 401(k)s have a higher limit,
- and if you're focused on 2010 but these numbers keep changing,
- in 2010 the 401(k) limit is $16,500
- and that's for just what you contribute to your 401(k)
- while the IRA limit is $5,000.
- This is an IRA. So one,
- 401(k) you can just participate with more money,
- so actually in both of these cases,
- as you approach your retirement, so after the age of 50
- So let me put that in the same thing so that we're comprehensive,
- so another similarity is that you can accelerate
- some of your, or you can have higher I guess
- deposits into your account.
- Accelerate after 50, which just means you can put more money
- than these limits than what I have right here.
- So these are your limits before 50,
- after 50, between 50 and 59 and a half (when you can start withdrawing)
- you can put a little bit more money,
- and these are constantly moving targets,
- but the general idea is that you can put more money inside of a 401(k).
- Now, the other difference is that a 401(k)
- tends to be organized by your employer.
- 401(k) organized by employer.
- And just from your point of view, that means two things:
- one is, the employer will often specify the investments,
- Specifies investments.
- So they'll actually run the 401(k) account for you
- Normally they'll be held by someone else,
- but it will be for your company,
- for company x, and the company gets to decide
- the universe of investments that you will be able to invest in,
- and the other thing, because it's run by the employer,
- the employer might match, which means for every dollar you put in,
- they'll put another dollar, even though they might go
- above matching, actually I think the current limits
- are approaching $50,000 for the total of the employee
- and employer match. So you can actually get a lot of leverage
- from putting in to a 401(k) if you have a very
- generous employer. And the other difference
- and this is really kind of a superficial difference
- because it's just what you see, is that with a 401(k)
- the money will be taken out of your paycheck,
- you will never see it, so taken out before paycheck.
- While with a traditional IRA, you will take the money
- invest it into an IRA account, and when you report your taxes,
- it will be reported as a tax deduction,
- so you won't have to pay taxes on it.
- Functionally they're the exact same thing.
- So you think about the pros and cons, if you have a 401(k)
- the option is available to you, it's a pretty good option.
- You're going to have a higher limit right over here
- and your employer might match it.
- And then the other thing, and this doesn't come into place a lot,
- but there's also the option of borrowing from a 401(k)
- without penalty. Borrowing from a 401(k),
- but you have to pay back interest to the 401(k) if you did that,
- and you cannot do that with a traditional IRA.
- Now when you're looking at this, well, why would anyone want to do a traditional IRA
- well there's a couple things, one could do both,
- or the other thing is traditional IRAs
- you have much more flexibility on where you want to invest,
- maybe your company says you can only invest
- in us, you can only invest in that company's stock,
- while in traditional IRAs you can invest in anything
- But, hopefully that clarifies things a bit for you.
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