What is the Difference Between a Roth, IRA, 401k and 403b?

Are you about to start investing for retirement?

Should you open a roth, ira, roth ira, 401k, roth 401k or 403b?

There are so many choices it’s difficult to know where to begin.

I get it, it’s confusing and you’re confused.

I was too when I started so I did some research to sort it all out.

You get to benefit from my research. I hope this helps you.

What a roth, ira and 401k are not.

First I want to clear this up.

A roth, ira and 401k are not investments. They are basically bank account classifications that tell the IRS how to handle taxing the account.

That seems to be a confusing point for some people.

So the statement, “I invest in my Roth” is not correct.

Once your money is in one of these accounts, you still have to invest in something like stocks, bonds, mutual funds or even real estate.

Now let’s get into the differences.

What is a Roth?

A “Roth” can’t stand by itself. Think of it as an adjective.

It needs a noun behind it to be correctly used.

For example, your options for opening an IRA account would be a “Roth IRA” or just an “IRA.”

An IRA is also called a Traditional IRA.

Roth just means that you will put after-tax dollars in the account and the IRS won’t ever tax you again.

Well you won’t get taxed if you play by the IRS’s rules but that’s a different topic for a different day.

So when you are 60 and pull your money out of a Roth IRA account, you won’t owe the IRS taxes.

Pretty sweet huh?

What is an IRA?

IRA stands for Individual Retirement Account.

Your contributions in an IRA can be tax deductible if you don’t participate in a retirement plan through your employer.

So you can use pre-tax dollars to put into your IRA.

This means your $100 goes a little bit further today. It depends on your tax bracket but $100 pre-tax dollars put into your IRA is like $80 after-tax dollars.

Making your contributions tax deductible helps with your cash flow today.

And that’s usually more important than when you retire.

You usually have more money and less expenses then.

What is a 401k?

A 401k a retirement account through your employer. It’s like an IRA.

How did it get it’s name? It’s the section of IRA tax code where this deduction can be found.

Most of the time, you put in pre-tax dollars to this account.

If your lucky, your employer will match your contribution.

If they do, your golden.

All 401k plans are different. Some employers restrict what investments you can buy but some do not.

Not being restricted in what you can buy sounds great but most of the time it’s a curse.

What is a 403b?

A 403b is very similar to a 401k but a 403b is offered through non-profit employers.

It got it’s name from the IRS tax code as well.

How do you pick the right account?

This depends on your financial situation.

But it really is a tiered approach.

If your employer matches your contribution, always start with your 401k or 403b.

That’s free money so don’t pass up free money.

If not, then you need to decide if cash flow is more important for you now or later.

If now, you’ll want to look at an IRA first.

Then if you have extra money, max out a Roth IRA.

Now all you need to do is decide what to invest in.

But that is a subject for another day.

Summary

It’s important to remember that a roth, ira, 401k, and 403b are not investments.

They are accounts that get different tax treatments.

An investment would be Home Depot stock which you would buy through one of those accounts.

It’s also important to remember “roth” can’t stand on it’s own.

It’s an adjective that gets paired with IRA, 401k, or 403b.

Understand those concepts and you’ll be on solid footing.

Do you have a 401k, IRA, or 403b? How did you decide which account to open?

If so, let me know what it was in the comments below.

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2 Comments

  1. Wonderful Blogpost thank you for sharing.

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