I keep hearing about these. What are they???
In short, they’re all types of retirement accounts. They are designed to encourage you to save up your money for retirement by allowing you to save money on your taxes, depending on which account type you choose and how much money you contribute to them. They also discourage you from taking money out of them before you retire by imposing taxes and penalties if you do so (except for under specific circumstances).
401Ks and 403Bs
401Ks and 403Bs both fall into the category employer-sponsored retirement plans. All this really means is that they are linked to your job, and with that come certain perks and responsibilities.
Depending on your employer, you might get your contributions matched up to a certain amount (meaning that for every X # of dollars or % of your salary that you contribute, your employer will contribute a certain amount of money to your account as well. Different employers have different rules for matching, so that can potentially be one of the things to look at when you’re considering a job.
Because your account is linked to your employer, if you take a job somewhere else, you will have to get a new account set up with your new employer. Each employer has a specific list of financial companies that they work with for their retirement program; sometimes that list is long, sometimes it’s just one company.
For more about employer-sponsored plans, click here.
What’s the difference between a 401K and a 403B??
The main difference is that 401Ks are for employees of privately owned, for-profit companies, whereas 403Bs are for employees of non-profit organizations and governments. Some 401Ks also offer investment options that 403Bs (which are typically limited to mutual funds) don’t, such as individual stocks and ETFs.
So what’s an IRA?
IRA stands for Individual Retirement Account. In contrast to 401Ks and 403Bs, IRAs don’t go through your employer; it’s all up to you. As long as you have earned income (wages, salaries, bonuses, commissions, tips, or earnings from self-employment), you can open and contribute to an IRA. When you change jobs, you don’t have to make any changes to your IRA.
For more about IRAs, click here.
Roth vs Traditional
There are two types of IRAs that you’ll often hear about: a Roth IRA and a Traditional IRA. Roth IRAs allow you to taxes on your contributions and then withdrawals (taking money out of your IRA) is tax free. Traditional IRAs involve the opposite: you can deduct contributions from your income taxes when you put the money into your IRA, but you pay income taxes on it when you withdraw it.
Some employers offer Roth 401Ks and Roth 403Bs as well, but it varies from employer to employer.
So what’s the difference between an IRA and 401K/403B?
The main differences between 403Bs/401Ks and IRAs are:
- Contribution Limits: as of 2022, 401Ks and 403Bs allow you to contribute up to $20,500 per year ($27,000 if you’re over the age of 50). IRAs are limited to $6,000 per year ($7,000 if over 50). *Employer matching does not count towards contributions limits*
- Loans: Many 401Ks and 403Bs offer the option to take a loan from your account and as long as you pay the loan back, you can access that money without having to pay the penalties and fees that are usually a result of early withdrawals. IRAs do not offer loans.
- Employer sponsored vs individual: When you change jobs, you have to get your 401K or 403B switched over to your new job . With an IRA, you don’t have to make any changes when you get a new job.
- Income limits: IRAs have certain limits on the amount that you can contribute(Roth)/deduct from your taxes (traditional) based on your income. For Roth IRAs, anyone with an annual income of $125,000 (single) or $198,000 (married filing jointly) can contribute the full amount. For more info about these income limits, click here.
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