Retirement Accounts: 401(k), IRA, and Roth Basics
Retirement accounts aren't just for people close to retiring. They're tax-advantaged tools that work best when started young — and understanding them in your teens or twenties puts you dramatically ahead. This lesson breaks down the most important ones.
Why retirement accounts are special
Retirement accounts get special tax treatment because the government wants people to save for retirement. That treatment takes two forms: either you don't pay tax on money going in, or you don't pay tax on money coming out. Over decades, this can be worth tens of thousands of dollars.
Contribute pre-tax (reduces income now). Pay tax when you withdraw in retirement.
Contribute after-tax (no deduction now). Withdrawals in retirement are tax-free.
401(k) — the workplace retirement account
A 401(k) is offered through an employer. You contribute a percentage of each paycheck, and many employers match a portion — free money that instantly amplifies your contribution. The match is one of the best guaranteed returns in finance.
Always contribute at least enough to get the full employer match if one is offered. Leaving the match unclaimed is leaving part of your compensation on the table.
Roth IRA — the account young people should know first
A Roth IRA is opened by you, not an employer. You contribute after-tax dollars, but the money grows completely tax-free — and withdrawals in retirement are also tax-free. For young people in low tax brackets now who expect to be in higher brackets later, this is often the most powerful option.
The 2024 Roth IRA contribution limit is $7,000/year (or your total earned income, whichever is less). You need earned income to contribute — a job, freelance work, or self-employment.
The power of starting young
Someone who contributes $3,000/year to a Roth IRA from age 18 to 28 (10 years, then stops) at 7% return typically ends up with more at retirement than someone contributing $3,000/year from age 28 to 65 (37 years). The first 10 years of compound growth, started at 18, can't be replicated by decades of contributions started later.
Why might a Roth IRA be especially advantageous for an 18-year-old?
Recap
- Retirement accounts get special tax treatment — either tax-free growth (Roth) or tax-deferred growth (Traditional).
- A 401(k) employer match is free money — always contribute at least enough to get the full match.
- A Roth IRA is often the best starting point for young people in low tax brackets.
- Next up: how to read an investment statement so you know what you're looking at when you check your accounts.