Simply put, they are all vehicles for you to save for retirement. Although they each are different in their own ways, they all benefit from some type of tax advantage.
401k & 403b
All you primarily need to know is that a 401k is used by a private, for-profit organization while a 403b is used by government/non-profit organizations. They offer virtually the same features but are just setup differently via the IRS guidelines. The investments/tax-deferred ability/rules, etc. are basically the same. A lot of people get confused when they hear 403b retirement plans because “401k” is usually used as a catch all.
One of the main features of these retirement plans is that they are setup so employees can save for retirement by directly making payroll contributions. Employers are also able to make a “matching” contribution. This is another benefit employers have been adding to help attract new employees and also retain them. The standard match tends to be around 3%. What does that mean? Well, if you make $100,000 and you are saving 3% annually in your 401k/403b, your employer will match that 3% by contributing to your 401k/403b as well. In a sense, you’ve just been given a $3,000 raise! We always recommend contributing at least the minimum to a retirement plan to get your employers match. If not, you’re giving up free money!
Remember, the $3,000 you saved for retirement through your retirement plan will come straight off your salary for tax purposes. So, in effect you will only pay taxes on $97,000. This is a great way to reduce your taxable income in the near term. The $3,000 will then grow tax-deferred until you go to withdrawal it during retirement.
The max an employee can contribute to a 401k/403b retirement plan, for 2020, is $19,500 and there is a $6,500 catch-up provision for employees over the age of 50. Therefore, the max for over the age 50 would be $26,000.
Traditional IRA & Roth IRA
If your employer does not offer a 401k/403b retirement plan then you can take advantage of an Individual Retirement Account(IRA). A traditional IRA works similar to a traditional 401k/403b. You get the same pre-tax contribution benefit; however, you don’t have the convenience of payroll deductions. You must contribute by making annual, monthly, and/or one-time contributions to fund your IRA. You are also allowed to make a prior year’s contribution all the way up until April 15th or when you file your taxes.
A Roth IRA is another great tool for saving for retirement. Unlike the 401k, 403b, and traditional IRA, you don’t receive the reduction in income for Roth IRA contributions. In a Roth IRA, you pay the taxes upfront, but your investment grows tax free! If you make qualifying withdrawals out of your Roth IRA, you will not have to pay any taxes! This can be a very powerful way to save for retirement.
One main difference between an IRA and your workplace retirement plan is how much you can contribute. Under the age of 50, you can contribute only $6,000 to an IRA. Over the age of 50, you are allowed an extra $1,000 catch-up.
Again, all of these are great vehicles to save for retirement. If you still have questions about what is right for you, don’t hesitate to reach out. This is something we help our clients with all of the time. Saving for retirement doesn’t have to be complicated!
Steven Dengler, CFP®
Financial Advisor / Director of Planning
Your local Towson Financial Advisors
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Mosaic Asset Partners, LLC is not affiliated with Kestra IS or Kestra AS. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results.