401k and IRA FAQs

What is a 401k?

A 401k is a retirement savings vehicle that is set up through your employer. It's a benefit at your job, just like your insurance. You put aside a percentage of your income to be invested in this account. The money you've put into the account is then invested in a plan you've chosen--typically made up of stocks, bonds, money market accounts, and a mixture of other investment options.

What is an IRA?

An IRA is an independent retirement savings account. It's very similar to the 401k, except that you set it up independently and have complete control over your options. So, while with the account through your employer they might limit what account types or investment options are available to you, with an independent account you get to make all of those decisions.

What is a Traditional account?

With a traditional account your contributions are taken from your pretax income. This means a couple of things. First of all, you have a bit more money to use for investing and earning you returns. This also lowers your yearly income as far as the federal government is concerned, which may make you fall into a lower tax bracket, which would then lower the percentage of your income you owe in taxes at the end of the year. It also means that you have to pay taxes on this income when you make withdrawals in retirements, which means your contributions aren't really a tax deduction so much as a tax deferral--you are merely putting off paying taxes until you reach retirement.

What is a Roth IRA or 401k?

With a Roth account your contributions are taken from your income after taxes have already been taken out, meaning that you can make withdrawals without paying taxes when you reach the retirement age.

What is the retirement age?

The retirement age is fifty nine years and six months old. This is the point where you can make withdrawals from your 401k and IRAs without paying the early withdrawal penalty.

What happens when I cash out early?

If you cash out before reaching retirement age you will have to pay state and federal taxes, as well as the early withdrawal penalty, which is ten percent. This can easily total thirty to forty percent and is a huge blow to your savings. Most people advise strongly against doing anything that may make you cash out early, as it is such a huge blow to your retirement.