The Different Retirement Accounts You Should Know—and How to Figure Out Which One You Need

What is a 401(k)? What is an IRA? And equally important, which one do you need? This cheat sheet can help steer your future in the right direction.

Types of retirement accounts - 401k and IRA explainer
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What is a 401(k)?

This employer-sponsored plan has a high contribution limit (in 2021, it's $19,500), so you can streamline your savings in one account. Contribute pre-tax income—which may lower your tax bill this year—then pay taxes on the funds when you withdraw them during retirement, says Cathy Derus, a certified public accountant and CEO of Brightwater Financial in Chicago.

What is a Roth 401(k)?

Some employers also give you access to a Roth 401(k), which you may use instead of or in combination with a traditional 401(k). This account requires you to pay taxes on the money as you put it in, but then you can make withdrawals tax-free during retirement. That may mean you'll get a bigger tax bill now than if you opt for a traditional 401(k), but the trade-off could be more money in retirement. The combined contributions of your Roth and traditional 401(k) plans cannot exceed $19,500 (unless you're 50 or over, in which case you can contribute an additional $6,500 each year).

What is an Individual Retirement Account (IRA)?

Like a 401(k), an IRA lets you make tax-deductible investments, which can help lower your next tax bill. "Deductions are limited based on how much you make and whether you're contributing to an employer-sponsored plan," says Derus. You can put in $6,000 a year before age 50 and $7,000 a year if you're 50 or older. It's a good option for those who are maxing out employer plans or wish to consolidate old plans.

What is a Roth IRA?

The Roth IRA is available to single filers earning less than $139,000 and joint filers earning less than $206,000. As with the Roth 401(k), you fork over tax on contributions and then make withdrawals tax-free during retirement. "A Roth IRA can make a lot of sense when you're in your 20s and 30s," says Coombes, because in the early years of your career you're likely in a lower tax bracket than you'll be in later. Avoid Roth plans if you expect your income to drop.

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