When planning for the future, the term ‘retirement account’ often comes up, but what does it really mean, why is a retirement account important, and should you opt for it?
5 Surprising Facts About Retirement Accounts
Here are five facts about retirement accounts that might surprise you and maybe help you plan better financially for retirement and avoid the retiree dilemma:
1. You Can Contribute More Than Your Salary
Your salary doesn't always equate what you earn. While a salary might come from a career path or by working for a company, if you have side hustles, freelance or receive alimony, you can contribute it to a retirement account too, provided they're considered earned income. This allows you to maximize your contributions and boost your savings with a retirement account.
2. Tax Advantages Aren't Just for Retirement
While retirement accounts are designed to benefit you when you're older, the tax advantages can start long before then.
Contributions to retirement accounts, such as a 401(k) or Individual Retirement Account (IRA), can be tax-deductible which will further reduce your taxable income in the years you contribute, culminating in an incentive to save more.
Additionally, the earnings on investments in these accounts grow tax-deferred, meaning you won’t owe taxes on the growth until you withdraw the money in retirement.
3. Your Employer's Contributions May Vest Over Time
One fact about retirement accounts is that there are many employers who offer matching contributions to your retirement account often under conditions like vesting. Vesting is an agreement between you and your employer where you must work for your employer for a pre-planned number of years before their contributions fully belong to you.
For example, if your employer has a five-year vesting schedule, you’ll need to remain employed with them for five years to retain 100% of their contributions. Knowing your employer’s vesting schedule is important, especially if you’re considering a job change, because it can affect your retirement savings.
4. You Can Have Multiple Retirement Accounts
Contrary to popular belief, you’re not limited to just one retirement account.
Many people benefit from having both a 401(k) and an Individual Retirement Account (IRA), or even multiple IRAs. Each account type has different rules, tax advantages, and contribution limits. By diversifying your retirement savings, you can strategize to maximize your tax benefits and investment opportunities.
For instance, you can max out your 401(k) contributions and still contribute to a Roth IRA, where your withdrawals in retirement can be tax-free.
5. Early Withdrawals Aren't Always Penalized
Another common misconception is that you’ll always face a hefty penalty for withdrawing money from your retirement account before 59 and a half years old.
While it’s true that the Inland Revenue Service (IRS) generally imposes a 10% penalty for early withdrawals, there are exceptions. For example, if you use the funds for qualifying expenses like purchasing your first home, paying for higher education, or covering certain medical costs, you may be able to avoid the penalty.
Closing Note
Why is a retirement account important?
Beyond the obvious reason of securing your (financial) future, retirement accounts offer benefits that can start impacting your finances today. Just as mentioned in this article, the advantages include tax leverage and flexible contribution options.
Knowing these facts can help you make the most of your retirement savings strategy.