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Video transcript

what I want to do in this video is to talk a little bit about 401ks 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 so it's very similar very similar to a traditional IRA 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 so you put money let me put it this way you put untaxed or you put pre-tax money in you put tree pre-tax money in money in the money can grow inside of either the 401k account or the traditional IRA K aw IRA account untaxed let me write that money money grows an account in account untaxed untaxed and then you can withdraw it you can withdraw the money you can withdraw can withdraw or start getting distributions from the account after after age after age fifty nine 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 fifty nine and a half you will then pay income tax you will then pay income tax then pay 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 have a much lower you'll have a much lower one I guess you'll be in a much lower incremental tax bracket and so your total overall tax bill might be lower also maybe something happens in terms of what the government does in terms of how they charge taxes and in general if you had to pay 50 cents 20 years in the future versus 50 cents today just present value of money tells you that the that 50 cents is going to be worth a lot less in the future or that it or the present value of it is a lot less so that's what some reasons to defer but of course you're you're not paying you're not just going to 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 total dispersals this Bert Versalles and in both cases you have to start taking disbursements from your account by 70 and a half so penalties penalties let me write it this way penalties penalties if you don't withdraw if you don't withdraw or you don't start withdrawing some of your funds by 70 and a half and there's some special cases if you're working and all these type of things now what happens if you would draw before age 59 and a half so before 59 and a half before 59 and a half so so far these everything I've listed is true of both 401ks and traditional IRAs if you withdraw before 59 and a half you are taxed taxed on withdrawal with drawl and on top of that you get it there's a 10% penalty on all the funds you receive 10% penalty 10% penalty and this is what you have to think about it unless you know if you just say oh I'm just always gonna max out my traditional IRA or 401k you got to make sure they're not gonna want that money before fifteen nine and a half because you might be facing this 10% withdrawal so these are all the cases that they're 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 pay get it get earrings on on on income in a taxed or on my investment in a tax deferred way and then paid some future date and most kind of forced me to make sure they strongly suggest that I shouldn't take out my money before fifty nine and a half so the ways that they're different so let's focus on the differences so the difference is between the two the difference is the difference is between the two one is for one case have a higher limit 401ks have higher limit have higher limit and if you if you're focused on 2010 but these numbers keep changing but in 2010 the 401k limit is sixteen thousand five hundred dollars and that's for just what you contribute into your 401k while the IRA so this is for a 401k 401k while the IRA limit the IRA limit is five thousand dollars this is an IRA so one 401k you can just participate with more money and actually in both of these cases as you approach your retirement so after the age of fifty so let me put that in the same thing just so we're comprehensive so another similarity is that you can have higher you can accelerate some of your so you can accelerate or have higher you can have higher I guess deposits into your into your account accelerate after after fifty which just means you can put more money than these limits that I have right here so these are your limits before you're fifty after fifty between fifty and fifty nine and a half when you can start withdrawing you can put a little bit more money and then these are constantly moving targets but the general idea is that you can put more money win a four in it's 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 organized by employer and just from your point of view that means two things one is the employer will often specify the potential investments specify specifies investments investments so they'll actually run they'll actually run the 401k account for you normally will 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 might be able to invest in and the other thing because it's run by the employer because the employer might match employer employer might match might match which means for every dollar you put in they'll put another dollar or even they might go above matching and you can actually go up to I think the current limits are approaching $50,000 for the total of the employee and employee and employer match so you can actually get a lot of I guess you could think of it leverage from putting in into a 401k 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 the 401k the money will be taken out of your paycheck you will never see it so taken out before paycheck take in out before paycheck while with a traditional IRA you will take the money invest it into a traditional IRA account when you report your taxes it'll be reported as a tax deduction and 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 401k if the option is available to you it's a pretty good option you're gonna have higher limit you're going to have a higher limit right over here and your employer might match it 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 401k without penalty borrowing borrowing from from a 401k but you have to pay back interest to the 401k account if you did that and you cannot do that with a traditional IRA now when you're looking at all this so like what why would anyone ever want to do a traditional IRA well there's a couple of things one you could do both or the other thing is with traditional IRAs you are 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 stock 1 a traditional IRAs and a traditional IRA you can invest in anything but hopefully that clarifies things a bit for you