You have many choices when it comes to investing your money. The two most common are brokerage accounts and retirement accounts.
Brokerage accounts are available at local brokerage firms and firms that operate online that are licensed to place investment orders, such as buying or selling shares of a stock, a mutual fund, or an ETF. You own the assets in a brokerage account and must pay tax each year on the earnings, which are called capital gains.
Retirement accounts are special accounts you can open at a variety of institutions, such as local or online banks and brokerage firms, that allow you to save for retirement. One of the advantages is that they allow you to pay less tax.
There are different kinds of retirement accounts available for individuals, as part of an employee benefit package at work, and for the self-
When you invest through a retirement account—
The most commonly used retirement accounts include individual retirement arrangements, the 401(k) plan, and the 403(b) plan. In order to have enough money to live comfortably for decades during retirement, it’s important to get in the habit of saving money in a retirement account.
Individual Retirement Arrangement (IRA) The IRA is a personal account available to anyone, regardless of age, who has taxable income. You can begin making contributions to an IRA as soon as you get your first job. However, you’re in charge of it, not your employer. With a traditional IRA you generally don’t pay tax on contributions or earnings until after you retire and start taking withdrawals. In other words, taxes on the account are deferred until sometime in the future. With a Roth IRA, you pay tax on your contributions up front. However, you never pay tax on them again or on any amount of earnings. You get a huge tax benefit with a Roth because your entire account grows completely tax free.
401(k) Plan The 401(k) plan is a retirement account offered by many companies. You authorize a portion of your wages to be contributed to the plan before income tax is withheld from your paycheck. A 401(k) plan offers participants a set menu of investment choices. You can contribute amounts up to certain allowable limits each year.
403(b) Plan The 403(b) plan is a retirement account offered by certain organizations such as schools, churches, and hospitals. It’s similar to a 401(k) in most aspects and also limits contributions each year.
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There are two main types of retirement programs found in the workplace: defined benefit plans and defined contribution plans.
A defined benefit plan is funded and managed by an employer and is commonly known as a pension. Employees don’t pay into the plan, pick investments, or manage the money in any way. Defined benefit plans give retired workers a specific, defined benefit, such as $800 per month for the rest of their life. The benefit paid depends on various factors, such as age, length of employment, and salary history. These plans have become rare in the workplace because they’re expensive to operate. However, some large companies, government agencies, and labor unions offer them.
A defined contribution plan is established by an employer but requires that the employee manage it. This type of plan includes the 401(k) and 403(b) plans. The retirement benefit that an employee will receive depends on the amount that’s invested and the performance of the chosen investments over the years. Defined contribution plans are more common because they’re less risky for an employer to administer.
If you could earn a guaranteed 100% return on your money, would you be interested? Many employers match a certain amount of the money you put in a workplace retirement plan. Say your employer matches 100% of your contributions to a 401(k) up to 3% of your salary. If you earn $30,000 a year and contribute $75 a month or $900 a year, that’s a contribution of 3% of your salary. With matching, your employer would also contribute $900. So you’d invest $900 and automatically get $900 from your company—