Opening up and making contributions to your first retirement account, and fully understanding your new IRA unfortunately aren’t synonymous. There’s a stark, and growing difference in accounts that are attended to, and accounts that are left to sit, and the key to your IRA being healthy and working how it should, it you, and only you.
When there’s so much resting on the actions you take now, those actions should be a fully educated move, and not a guess. There are common errors that new IRA holders make, and they’re easily avoided, so let’s dive in.
Being ignorant to your account options
If you’re a professional, you’ve most likely heard the industry terms thrown around, IRA, 401K, Traditional, Roth, and so on. You may not know the difference, but let’s fix that.
401K – A 401K is a retirement plan that’s sponsored by your employer, you’re able to save a percentage, or a determined sum of your paycheck, before taxes, and have that money put into your 401K. Some employers offer matching contribution programs, where they will match your contribution up to a certain percent.
IRA – An IRA stands for Individual Retirement Account, you as an individual open the account with a bank, brokerage firm, or IRA administrator, you determine the account type, amounts you want contributed, and in some cases (if you have what’s called a self-directed IRA), you decide the assets to be held within your IRA.
Traditional IRA – A Traditional IRA is one type of account, of many, that you can pair with your IRA. A Traditional IRA is probably one of the most common account types. How it works is that you contribute pre-taxed money to your account, which allows your account to grow tax-deferred. At retirement age (59 ½), when you start taking distributions from your Traditional IRA, taxes will apply to your withdrawn money.
Roth IRA – Roth IRAs are different from Traditional in that your contributions are made with money that’s already been taxed, so your earnings grow at a tax-free rate. When it comes time to take distributions from your Roth IRA, no taxes are taken from your withdrawn money.
So now that we know the difference between and IRA and a 401K, it’s important to state that you’re allowed to have both a 401K, and an IRA. As you change jobs or careers, it’s kind of inevitable you will have both.
Not meeting matching contributions
This is a cardinal sin in the retirement industry. Say you’re lucky enough to have an employer that offers a 401K program, and along with that program, they offer matching contributions. TAKE. IT. That’s essentially free money. My personal favorite oxymoron. These are basically the options you’ll be given with a 401K matching program:
Fixed match: Your employer will match 1$ for every 1$ you contribute to your plan, usually up to a specified amount, such as 5% of your pay.
Percentage match: Your employer matches the percentage of money you contribute into your 401K. again, usually at a cap of, for example, 3%.
Come back next week for part two, to read up on the rest of the most common IRA mistakes, and how to avoid them.