This will be the most heavily developed part of my site including all different types of money resources that are informative and amazing... for now though- we'll start you with this:):
*a simple intro to money market accounts, 401Ks, IRAs, and Roth IRAs*
Hiya! Here is a really quick reference/clarification on the accounts that you hear about every day to help you know whats up; so that you actually know what you're nodding your head about in affirmation when your friend-who-works-in-finance-and-seems-to-speak-another-language-sometimes-starts talking about the "asset allocation" in her 401K. Asset allocation is a little ways off, so we're gonna start with the basics. This is just a really quick intro to retirement accounts that will help you next time you’re with said friend and wanna look sexy and cool (your friend is looking hotter every day) and you want to impress him/her with your personal finance acumen.
- a savings plan for retirement offered to you by the company you work for.
- The process goes like this: When you first start to work for a company that offers you "participation in a 401K", you sign up (obviously the vital step in this process) and determine how much of your income you want to put into this savings account; i.e. 5% of your income, 10%, etc. Then, each paycheck, this percentage of your income is taken out of your check (before you see it, so you don’t even notice its gone) and put into various investments. Now, you decide where you want your money to be invested. The company usually narrows down your options but you usually have a choice of stock, bonds, mutual funds, money market accounts, international funds, etc. Then, every paycheck, money is subtracted from your check and invested based on what you wanted in your original set up. Example: right now, my money in my 401K is in 80% stocks, 20% bonds. So for every hundred dollars in my 401K, 80$ of that money is invested in the stock market and 20$ of it is invested into bonds. (It’s a lot more in depth/complicated than this- but this is the conceptual explanation of it).
- Often, the company will “match” your money up to a certain percentage. This basically means that for every dollar you put into your account, your employer will match it up to 6% (usually the max) of your salary. So if you make $40,000 in a year, you will want to put at least $2,400 into your 401k (this is 6% of 40,000) because your employer will match that amount. $2,400 in one year of free money? Yes please.
- Its tax deductible. That means that if you make 40,000$ in one year and you put 1,000$ into a 401K- you’re taxed as if you’ve only earned 39,000$ that year. (for this specific year you’d pay 250$ less in taxes as a result!)
- You pay taxes on your money when you withdraw it. This is called “tax-deferred” because you defer (or postpone) paying taxes on your money for years. Which, although you are still having to pay taxes -they come out somewhere, I know, I know, annoying, but lets just all take a DEEP breath and move along- because your money has been allowed to grow tax free over the years, it can grow much larger (because of the principle of compounding that we can talk about later).
- If you are in a higher tax bracket at retirement age (i.e. paying more in taxes because your income is higher and people who make more, pay more taxes) than you are currently, you will be taxed higher on the money than you would have been when you originally put it into the account.
- You can’t take this money out of this account until you are 59 ½ years old; if you do you could end up paying full taxes PLUS a 10% penalty tax on the money you take out (depending on the reason for taking it out). So basically, any money you put in this account is going to stay there for the next 40 or so years. Moral of the story: kiss this moolah adios and forget about it.
- You MUST start taking money out of this account at the age of 70 ½.
- a private savings account for retirement set up by you (read responsibilty, knowledge, and proactivity here) through banks, brokers, or mutual fund companies that you enroll in when you are not offered a 401K through your job. Similar to a 401K, you determine at the outset how you would like your money invested and it is actively managed by someone else (i.e. the company you get your IRA through- Vanguard, Fidelity, etc.)
- You can withdraw this money at any time. There is a catch here: you can only withdraw yourcontributions (the money you’ve directly put in) to this account, not the interest you’ve gained on this money and if you do, you pay penalties and taxes. There are specific instances and requirements however, that allow you to withdraw all of the money without paying any penalties (i.e. buying a home, tuition expenses).
- There is no final date for withdrawals. You can save money in this account until you pass away and leave it to your heirs as inheritance. (You can’t do this with other retirement accounts)
- This account is not tax deductible. So that when you put your money into a Roth IRA—lets say you make 40,000 dollars again in one year and put 1,000$ into a Roth IRA--you will still be taxed on making 40,000$ in a year, not 39,000$ as you would with a 401K.
- There is a maximum amount of money you can put into this account every year; its currently at 5,000$ a year for 2010.
- a private savings account for retirement set up by you through banks, brokers, or mutual fund companies that you enroll in when you are not offered a 401K through your job. Similar to a 401K, you determine at the outset how you would like your money invested and it is actively managed by someone else (i.e. the company you get your IRA through- Vanguard, Fidelity, etc.).
- Often tax deductible like the 401K. (check on this though) So again, if you make 40,000$ in one year and you put 1,000$ into a 401K- you’re taxed as if you’ve only earned 39,000$ that year.
- Like the Roth IRA, money can be withdrawn before 59 ½ , but certain financial penalities will apply based on the reason and whether or not you take out all of the money or just your contributions.
- You must start withdrawing money at the age of 70 1/2 .
- A traditional IRA (in general) will have a mix of characteristics of 401Ks and Roth IRAs.
- a fancy name for a savings account (usually online) that earns a higher interest rate on your money than a normal savings account (think: your Bank of America savings account that is linked to your checking account)
- because it is not a “transaction account” (think “checking account”) it only allows withdrawing money or writing checks 6 times a month- combined.
- this type of account is a perfect place to put money that you don’t necessarily need access to on a daily basis; perfect for your emergency savings money (3 months of bills is suggested) because it can grow more than in your normal savings account.
- sometimes has a required minimum balance to open or maintain anywhere from 500$-5,000- but not always and its very easy to search for accounts with no minimum balance or deposit.