IRA’s & 401k’s – What’s the Difference?

FC 401k

Individual Retirement Arraignments aka IRA’s

I bet you always thought IRA was short for Individual Retirement Account huh?  Nope, it’s actually an Arraignment as weird as that sounds.

So what are they and how can you use them?

There are two types of these IRA’s, a Traditional IRA and a ROTH IRA (named after the late Senator from Delaware named William ROTH).

Traditional IRA – “pre-tax” Account
This account allows you to contribute pre-tax money if you don’t have access to a pre-tax retirement account within your employer.  You can contribute annually: $5,500 if under age 50 and $6,500 if over age 50
You can’t take any money out of the account until age 59 1/2 or the IRS will hit you with a 10% penalty plus your ordinary income rate.

ROTH IRA – “after tax” Account
This account allows you to contribute after tax money (your take home pay) and the only restriction to contributing is based on how much you make.  If you make over the following then you can contribute directly to a ROTH IRA (there is a potential ‘back door’ way to contribute still but that gets a little more tricky):

  • Single filer 2018 –  $120,000 with a reduced amount of contributions up to $135,000
  • Married filing jointly 2018  – $189,000 with a reduced amount of contributions up to $199,000

These limits are based on your adjusted gross income so once you take all of your tax deductions.

The same rules apply on the taking money out prior to 59 1/2.  The IRS will hit you with a 10% penalty and you pay taxes on the growth for the early withdrawal instead of getting that money tax free.

457 Deferred Compensation / 403b plans / 401k plans
Depending on where you work will dictate which kind of these retirement plans you have available to you and some of you may have access to more than one of these.  The following are usually available with these types of employers:

  • Government or Municipal employers – 457 deferred comp (and in some cases a 401k plan)
  • Public Schools and certain tax exempt employers – 403b plans
  • Corporate or private jobs – 401k plans

Don’t get all wrapped up in the number names; think of it just like a penal code law book, the number just represents where it is found within the Internal Revenue book.

457 Differed Compensation
This type of retirement plan allows you to defer your compensation now so that when you leave your employer you can then take that compensation then.  This means that after you leave your agency you are not subject to the 10% IRS early withdrawal penalty.  If it is a pre-tax account (most are) then you will only pay the ordinary income taxes on it.

You can additional defer up to $36k of your last vacation/sick leave/ comp leave check, which can potentially save you a lot on taxes.  That $36k can be impacted based on how much you have been contributing so check with your plan administrator to determine the exact amount you can differ of that last check.  This is a good way to limit taxes and take your money out incrementally at a potential lower tax rate.

403b Plan:
This type of plan allows you to out pre-tax money into a retirement plan.  You are typically allowed to take withdrawals out at age 59 1/2 without a penalty

401k Plan:
This plan works similarly to the 403b except oftentimes you have the ability to pick the pre-tax contributions or the after tax ROTH contributions.  You are also typically able to take withdrawals out at age 59 1/2 without penalty.

Matching Contributions
Some of you are fortunate enough to have a employer that matches your contribution in these plans.  If they offer a match you MUST take advantage of this.  It is FREE money which can equates to a potential 100% return on your money.  You most likely can’t find that kind of return anywhere so don’t throw it away.

Besides the 100% return, the companies match also grows, so as it does that money is essentially free growth as well.  Note that all matching contributions are done so on the pre-tax side of things so when you start to take out withdrawals you will pay ordinary income taxes. Contribution limits for these accounts are, 2018 – $18,500 if under age 50, and $24,500 if over age 50

*Remember www.irs.gov is a great resource when it comes to learning more about each of these accounts, to include rules, definitions, and contribution limits each year!!

**Disclaimer Alert— As always, when it comes to taxes, you should consult your accountant for specific tax advice, and how each of these types of accounts can effect your specific tax situation!!!

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