Retirement still seems many years away for millennials.
But (and I know it’s a cliche) it’s never too early to prepare for your future. Decades have a habit of flying by quickly, and you don’t want to approach your 50s or 60s without the financial freedom to retire comfortably. Especially since some financial experts estimate you’ll need at least 80% of your pre-retirement income to live comfortably in your Golden Years. Every millennial needs to know a few retirement terms; they’ll be strategic tools for building and securing your nest egg.
Traditional IRA
An Individual Retirement Account (IRA) is a savings account designated specifically for retirement. Unlike regular savings accounts, an IRA offers tax benefits. For one thing, the money within them grows tax-free. Other specific terms and requirements include:
- You can contribute up to $6,500 per year (or $7,500 if you’re 50 or older) in an IRA (in 2023)
- All IRA contributions are tax-deductible up to the IRS limits
- No taxes on IRA funds until you withdraw the funds
- You must wait to withdraw money from your IRA until you are 59½ or older to avoid penalties
- You must start withdrawing money at age 72 (73 if you reach age 72 after December 31, 2022)
Overall, an IRA gives you the opportunity to grow and compound your retirement investment faster than it would in a taxable account. This type of account is easy to open at nearly any bank, brokerage company, or investment firm.
Read about micro-investing and how to get started with our complete guide: Micro-Investing: What It Is, Why It’s for You and How to Start.
Roth IRA
A Roth IRA is very similar to the traditional IRA described above, with just a few distinct differences. The main one is you don’t get a tax deduction for the funds you deposit. Rather than allowing tax-deductible contributions, a Roth IRA allows you tax-free distributions (withdrawals): You don’t owe taxes on the money when you take it out, as you do with the traditional IRA.
As with the traditional IRA, money within the Roth account grows tax-free. You never pay taxes on withdrawals that equal the amount you originally put in. Any earnings or gains are more restricted, but once you hit retirement, you can withdraw them free of tax.
Also, you’re never compelled to take distributions from the Roth at any age.
Some income restrictions are in place to prevent extremely high earners from taking advantage of the Roth IRA system. Still, in 2023, if you make less than $153,000 individually or less than $228,000 as a married couple filing jointly, you can invest up to $6,500 into your Roth each year ($7,500 if you’re over 50).
401(k) Plan
A 401(k) is a retirement savings plan sponsored by employers. Available only through the workplace, it gives employees a safe place to save and invest a chunk of their paychecks before taxes are deducted from them. Employees choose how to invest the money, usually from a range of mutual funds the plan offers.
Here are the most important points you need to know before opening a 401k with your employer:
- Individuals can contribute up to $22,500 a year (or $30,000 a year if age 50 or older) in 2023
- The amount you elect to invest in your 401(k) is taken “off the top” of each paycheck, which lowers your taxable income
- You can contribute to a 401(k) and an IRA at the same time
- Many employers offer to match a portion of what you contribute. This is an excellent perk that gives you free money and a huge savings incentive
Remember that 401(k) accounts have rules and regulations, such as paying taxes on everything you withdraw in retirement.
Annuity
An annuity is an investment plan that provides set payouts throughout your retirement. It’s established through a contract between you and an insurance company rather than investment firms or banks. You can purchase an annuity by making monthly payments or paying a lump sum upfront. When you hit retirement, your insurance plan enters its amortization period, and you start getting paid.
The details of an annuity can be a little tricky. But here are the basics you need to know:
- Fixed annuities guarantee a specific rate of interest and payout
- Variable annuities allow you to choose your investments; fluctuating with their performance, these annuities are high-risk and potentially high-reward
- Indexed annuities correlate to the stock market and may increase your monthly payout during retirement
Annuities can work well for people who like (or need) the discipline of money being doled out to them periodically. However, it’s difficult to get your money out of an annuity once the distribution terms are set, which is a huge problem if you encounter a financial emergency. Annuities are also notorious for their fees, which are as high as 3% per year.
Why Should You Know These Retirement Terms?
There’s no single correct answer regarding retirement planning as long as you are making progress in protecting your financial future. These plans are the most popular, and you’ll probably hear friends, relatives, and financial advisors discuss them. You’re ready to start saving now that you know what they mean!
