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1. 401(k)
A 401(k) is a retirement plan that an employer may offer. You decide how much to save from each paycheck (up to the maximum contribution amount), and that contribution goes straight into your account, often before taxes are taken out. That means you lower your taxable income and save for the future.
Here’s the cherry on the top: Many companies offer matching contributions (more to come on this), which is a real boost for retirement savings.
2. Employer Matching
If your job offers to “match” a portion of your 401(k) contributions, it could be smart to take advantage of it by contributing enough to maximize the match.
Here’s how it usually works:
- Partial Matching: With partial matches, employers commonly match 50% of what you put in, up to a certain amount. So if you put in 6% of your salary, the employer will provide a match equal to half of that amount, which would be 3%.
(Note: Employer contributions have a maximum limit and can only match up to 6% in any scenario. For example, if you contribute 8%, your employer will still only match half of 6% of your salary.)
- Dollar-for-dollar: Your employer will fully match your contributions, dollar-for-dollar (100%), up to a specified limit. For example, if you contribute 3% of your salary, your employer will match the same amount.
3. Contributions
This one sounds simple, but it’s at the heart of every retirement plan. A contribution is the amount of money you (or your employer) add to your retirement account.
What’s important to know is the annual limits set by the IRS, meaning there’s a cap on how much you can contribute to a 401(k) or IRA each year. These limits often increase slightly over time, so it's worth keeping tabs on them each year to maximize your savings.
4. IRA (Individual Retirement Account)
An IRA is another type of retirement account, but with additional tax perks. You open one on your own (outside of work) and start saving at your own pace. Every time you leave a job, you can rollover your 401(k) into your IRA so you stay in control instead of leaving it behind and trying to remember it later.
There are a few types of IRAs:
- Traditional IRA: Contributions may be tax-deductible now, but you'll pay taxes when you take the money out in retirement.
- Roth IRA: You contribute after-tax dollars now, and qualified withdrawals later are tax-free.
- SEP IRA: Designed for the self-employed and business owners, the SEP IRA allows higher tax-deferred contributions than a traditional IRA, with taxes paid at withdrawal. Only employers can contribute to this plan, employees cannot.
- SIMPLE IRA: Businesses with 100 or fewer employees who earned over $5,000 in the two preceding years are eligible. Employees can make tax-deferred contributions via payroll deductions, and employers can also contribute.
