What is an IRA? What is a 401k?: Fundamentals of Investing

Hello and welcome back to our Fundamentals of Investing series. It's been a while since we've made a video like this, but we wanted to get back to explaining important concepts you need to know as you work to grow your retirement nest egg and build your personal wealth. I'm Brian Dress, Director of Research here at Left Brain, joined by our CEO and Chief Investment Officer Nolan Langford. Thanks for joining us.

It's great to be here and excited to be talking IRAs and 401(k)s.

We're here today to talk about retirement accounts. As Nolan said, there are a number of different options with different eligibility requirements and contribution limits. Today we're speaking about two of the most commonly used retirement accounts. That's IRAs, individual retirement accounts, and 401(k)s. We're going to try to just define terms for you all and, uh, help you understand what your eligibility requirements are, contribution limits, and all of that, and the differences between the two. So we'll start with the first question, Nolan, which is, what is an IRA? What's the eligibility and what are the contribution limits?

IRA, it stands for Individual Retirement Account. It's an account that allows savers to put money away on a tax-deferred basis. For most IRAs, money goes in pre-tax, it grows on a deferred basis, meaning that savers do not pay income taxes on the growth year only at withdrawal, 59 and a half at the current age that you can withdraw without penalty. Uh, contribution limits, $6,000 per year. If you're lucky enough to be over age 50 like myself, you can contribute another $1,000 per year for a total contribution of $7,000 per year.

Excellent. And there are actually a couple of different types of IRAs, but we're not going to cover that in today's video, but look for a future video where we do cover those those nuances. And then we'll move on to the second, which is, Nolan, what is a 401(k)? And again, who's eligible and what are the limits?

So 401(k) is a tax-deferred savings plan established through one's employers. So you have to actually be a company to set one of these up. But if you're an employee that works for a company that offers one, allows you to contribute to this plan out of your paycheck pre-tax. Most companies will also match your contribution. So if I get paid once a month and I put $1,000 per month into the plan, comes right out of my paycheck. I do not pay taxes on that money as it goes into the plan. The money grows on a tax-deferred basis and it's taxable similar to an IRA at retirement for me. Uh, currently at age 59 and a half, I can start to withdraw money without penalty. And for every $1,000 in my example that I put in, most companies offer a match. That is, in addition to my $1,000 that goes in, my employer will also put some money into my plan to contribute toward my retirement. Unlike the IRA, it has a higher limit of contribution. As an employee, I can put in up to $20,500 per year. And if you're lucky enough like me to be over age 50, The IRS allows what they call a catch-up. That current amount is $6,500 per year for a total maximum contribution of $27,000 that can go in from me, from my paycheck. That doesn't count the amount that my employer can contribute on my behalf.

We want to go ahead and make sure everyone knows these are 2022 figures. I know this video is going to last hopefully longer than that, so If it's after 2022, make sure you take a look and make sure you got the right limits. And then finally, Nolan, and you know, there's a way to roll from one from to the other, from what, there is a way to roll investments from one to the other. And it's another video we're going to put out here in the next few weeks. But what are the main differences between a 401k and an IRA?

So the big, there are a lot of similarities, but there are a few differences. The first is if I'm in a 401(k), remember that has to be attached to an employer. So generally, if I'm self-employed or if I'm not employed, it's very unlikely I'm going to have access to put money into a 401(k) because generally that money is going to go in through my paycheck. The other, the other benefit is in a 401(k), remember an employer establishes this plan and then they will generally always contribute to the plan. So I have more than my contributions that are going in. In an IRA, remember, I do not have to have my employer establish that for me. I can do that on my own through any financial institution, but the limit is not as high either. Remember, in a 401(k), the contribution limit's $20,500, but in an IRA, an individual retirement account, it's only $6,000. And unlike a 401(k), in an IRA I have no one else contributing to that plan other than myself. Lastly, because the IRA is an individual plan, it's portable, meaning I can control it. I can decide what investments go in and what go out and what institution it's held at. In a 401(k), I don't have those choices. I can only invest in the limited investment options my employer give me. And I'm also tied to whatever financial institution my employer has contracted to manage the plan.

Well, thank you for explaining all those differences in the 401(k) and the IRA. Again, look, look for future videos in the series of Fundamentals in Investing. We'll tell you more about what you can do with a 401(k) when you change jobs. Look for that video coming up in the future, but until then, join us again next time.