Because of the magic of compound interest, it’s in your best interest (see what I did there?) to start saving for your retirement as soon as possible. But benefits aside, if you haven’t opened a retirement account — or started investing at all — it can seem super intimidating.

“Why put money where I can’t access it?”

— You, when you think about your employee-offered retirement plan

Or maybe you’ve heard that having an IRA is a good idea and you even thought about opening one. But once you realized there were different options to choose from, you panicked, shut your laptop, and thought to yourself that there was plenty of time to figure this stuff out later.

The truth is, because of compound interest, the sooner you figure this stuff out the better. A lot better.

If you invest $200 each month starting at age 25, and you average a 7% return on your investment, by age 65 your portfolio would be worth more than $520,000 even though you would have contributed only $96,000.

If your friend invested the same $200 per month, but waited to start until she was 35, she would only have $245,000 by the time she was 65 — less than half of what you do, just by skipping out on those first 10 years.

The wilder part is that if you only invested $200 per month for 10 years (stopping when you’re 35), and your friend started at 35 and invested $200 each month until she turned 65, you would still have more at age 65 than her, despite investing for only 10 years compared to 30.

The key here is time.

So, to try and make things a little less intimidating, I thought I would do a brief roundup of some of the most common retirement accounts.

First, you may be wondering what makes a retirement account different from a regular investment account? The biggest difference is that retirement accounts are tax advantaged, meaning rather than paying taxes on your investment income each year, you only pay once — either when you make your contribution (tax-exempt), or when you withdraw money (tax-deferred). This can save you a lot of money in the long run.

Tax-deferred: A retirement account that allows you to contribute funds from your paycheck before you pay tax. This lowers your end-of-year tax bill. You’ll pay tax when you withdraw the money from your retirement account.

The trade off is that retirement accounts come with certain rules and regulations about how much you can contribute each year and when you can withdraw the money without paying a penalty.

Side note: In this post I just cover the basic employer-offered accounts and IRAs, but at some point, I’ll loop back around to talk about more options for those who are self-employed.

Below is a breakdown of various accounts to make it a little easier to get started and make your first contribution:

Employer-Offered Accounts

401k and 403b plans

When you think of a retirement account, 401k is probably the account name that comes to mind.

403b plans are essentially the same as a 401k, except they can only be offered by nonprofit companies, religious groups, school districts, and governmental organizations.

The only real difference is that 403b accounts are exempt from various administrative processes, which allow their administrative costs to be lower.

Many employers offer these accounts to their employees — often with a match if the employee contributes a set amount. At my job, as long as I put 3% of my (pre-tax) income into my account, my employer kicks in an additional 5.14%.

Anytime your employer offers a match, DO IT! Otherwise you’re leaving free money on the table.

Once you set up your 401k or 403b contributions through your work, they’ll automatically come out of each paycheck (like your health insurance), so you don’t really have to think about it. Plus, since the money gets deducted from your paycheck before it hits your checking account, you never really see it, so you’re less likely to miss it.  

When investing, it’s usually best to use the crockpot strategy; set it and forget it.

The Need-to-Knows of 401k and 403b Accounts	The Details	What It Means
Tax Advantage	Tax-deferred	You contribute before taxes are deducted from your pay.
Maximum Annual Contribution	$19,500 (including employer match) *100% of gross annual compensation if you make less than $19,500	This maximum annual contribution is the maximum for all 401k, 403b, and SIMPLE plan contributions combined. If you’re 50 or older, you can make a catch-up contribution of an additional $6,500 per year.
Withdrawal Age	59 1/2	Once you turn 59 1/2, you can draw from your account without paying a penalty.
Early Withdrawal Penalty	10% of the amount you withdrew	Plus, you’ll pay income tax on the original withdrawal amount.
Required Minimum Distribution Age	72 years old	You must start making withdrawals from your account once you turn 72.

457b plans

A 457b plan, also called a deferred compensation plan, is only available to state and local government employees.

The plan logistically functions the same as a 401k or 403b: It’s offered through an employer, your contributions are deducted from your paycheck pre-tax, and your earnings are tax-deferred until withdrawal. The perk is that you can withdraw your money penalty-free once you leave your job or retire, even if it’s well before the age of 59 ½.  That makes this type of account especially attractive to people who want to retire early or who want more flexibility.

Employers usually don’t offer a match 457b contributions, so it’s best to contribute at least enough to get the employer match into your 403b. Then, direct any additional contributions you were planning to make to your 457b to allow more flexibility in the future.

The Need-to-Knows of 457b Accounts	The Details	What It Means
Tax Advantage	Tax-deferred	You contribute before taxes are deducted from your pay.
Maximum Annual Contribution	$19,500 (separate maximum from all other employer-sponsored retirement accounts) *100% of gross annual compensation if you make less than $19,500	If you were a high-income earner, you have the ability to put $19,500 into your tax deferred 457b plan and another $19,500 into your 401k or 403b plan, lowering your tax bill by $39,000. If you’re 50 or older, you can make a catch-up contribution of an additional $6,500 to both accounts.
Withdrawal Age	None (woohoo!)	You just can’t withdraw while you are currently working for the employer who sponsors it.
Early Withdrawal Penalty	None (woohoo again!)
Required Minimum Distribution Age	72 years old	You must start making withdrawals from your account once you turn 72.

SIMPLE IRA

It’s not that I’m so jazzed about SIMPLE IRAs that I just have to write it out in all caps. SIMPLE stands for savings incentive match plan for employees, and functions similarly to a 401k in that your contributions are deducted pre-tax, and the money accumulates until you begin withdrawing at retirement. A SIMPLE IRA is a retirement account that can be offered by small employers that have 100 employees or less.

In a 401k or 403b plan, employers get to choose if they will offer a match incentive. The cool thing is that employers who offer a SIMPLE IRA are required to either match employees contributions up to 3% or contribute a flat 2%, whether an employee opts to contribute or not.

If you leave your job, you won’t be able to rollover your SIMPLE IRA into anything but another SIMPLE IRA until you’ve had the plan opened for at least 2 years.

The Need-to-Knows of 457b Accounts	The Details	What It Means
Tax Advantage	Tax-deferred	You contribute before taxes are deducted from your pay.
Maximum Annual Contribution	$13,500 *100% of gross annual compensation if you make less than $13,500	If contribute to another employer sponsored account such as a 401k or 403b, your total contributions to all accounts cannot exceed $19,500. If you’re 50 or older, you can make a catch-up contribution of an additional $3,000 per year.
Withdrawal Age	59 1/2	If you withdraw before you reach 59 1/2, you may face a penalty.
Early Withdrawal Penalty	10% of the withdrawal amount	Also, if you try to rollover your funds to another account within the 2-year waiting period, you’ll be hit with a 25% early-distribution penalty.
Required Minimum Distribution Age	72 years old	You must start making withdrawals from your account once you turn 72.

---

Individual Retirement Accounts (IRA)

Individual Retirement Accounts, also known as IRAs, are opened by you, not an employer. There are two main types of IRAs: Roth and Traditional.

Roth IRA

In a Roth IRA, you contribute after-tax money to your account. You won’t have to pay taxes when you withdraw your earnings in retirement, which means your money is growing tax-free. This is especially good if you think you’ll be in a higher tax bracket in retirement than you are in now.

Tax-exempt: A retirement account that you contribute to after you’ve already had income taxes withdrawn. When you withdraw funds at retirement, you won’t pay tax on them, because you already did before you deposited.

Roth IRAs also allow for some flexibility in that you can withdraw your contributions at any time without having to pay taxes or penalties. However, if you withdraw any of the earnings before you are 59 ½ you will be subjected to a 10% penalty.

You can avoid this penalty if you are using the withdrawal for a first-time home purchase (up to $10,000), a qualified educational expense, or to pay for health insurance while you are unemployed.

Another benefit of the Roth IRA is that distributions aren’t included as income in retirement, allowing you to keep your overall tax bracket down, which can have an effect on healthcare and Medicare premiums.

This type of account is not available if you make over a certain amount. As of 2020, if you are single and make more than $124,000 per year, you won’t be able to contribute to a Roth IRA. Same if you are married (filing jointly) and make more than $206,000 per year.

The Need-to-Knows of Roth IRAs	The Details	What It Means
Tax Advantage	Tax-exempt	You contribute after you’ve already paid taxes on your money.
Maximum Annual Contribution	$6,000 *100% of gross annual compensation if you make less than $6,000	If you’re 50 or older, you can make a catch-up contribution of an additional $1,000 per year.
Withdrawal Age	The principal that you contribute can be withdrawn at any time without penalty. Earnings cannot be withdrawn until 59 1/2.	Earnings cannot be withdrawn until age 59 1/2 except for a qualifying expense. Earnings must have been held in the account for a minimum of 5 years.
Early Withdrawal Penalty	10% of the withdrawal amount	Only if you withdraw from your earnings, other than for a qualifying expense.
Required Minimum Distribution Age	None	Woohoo!

Traditional IRA

Contributions made to a traditional IRA are tax-deductible (and you get to claim them whether you itemize your deductions or not) and therefore lower your taxable income for the year. Your money grows (tax-deferred) so you only pay taxes when you withdraw from your account, much like a 401k.

Anyone can open and contribute to a Traditional IRA, but whether your contributions will be tax-deductible will depend on your income.

If you’re single and make less than $65,000 per year, all of your contributions will be deductible. However, if you’re single and you make over $75,000, none of your contributions will be deductible. And if you make somewhere in the middle, you’ll receive a partial deduction.

Married couples (filing jointly) who make under $104,000 per year will get the full deduction. If you make over $124,000, you get no deduction.

However, if you are not already offered a retirement plan through your employer, you can deduct all of your contributions, no matter your income.

Like a Roth IRA, you can avoid the 10% early withdrawal penalty if the withdrawal is used for a qualified expense such as a first-time home purchase (up to $10,000), a qualified educational expense, or to pay for health insurance while you are unemployed.

The Need-to-Knows of Roth IRAs	The Details	What It Means
Tax Advantage	Tax-deferred	You’ll pay tax when you withdraw at retirement.
Maximum Annual Contribution	$6,000 *100% of gross annual compensation if you make less than $6,000	If you’re 50 or older, you can make a catch-up contribution of an additional $1,000 per year.
Withdrawal Age	59 1/2	Except for a qualifying expense.
Early Withdrawal Penalty	10% of the withdrawal amount	Plus, you’ll pay tax on it.
Required Minimum Distribution Age	72	You must start withdrawing from your account at age 72.

---

My Retirement Savings Strategy

I use a variety of these accounts in saving for my retirement.

I contribute just enough to my 403b to earn my full employer match (again, I don’t want to be leaving free money on the table). So I contribute 3% and my employer kicks in an additional 5.14%.

Then I make the bulk of my contributions to my 457 plan, which amounts to $195 every other week. It offers the same tax advantages of the 403b but offers more flexibility because there is no withdrawal age.

I also contribute $40 per week to my Roth IRA. I like that these funds are growing tax-free and that it offers me additional flexibility. I can withdraw from my contributions (but not my earnings) at any point.

My plan is to increase my contributions once we buy a house, since right now I’m also sending money to a high-interest savings account to save up for that.

Remember, don’t wait to start investing until you feel like you can put a lot of money in each month. The time your money has to grow matters more than the amount you put in. Sure, the more you can invest the better, but if you only can contribute $5 each month, then start with that.

Building the habit and the mindset is what matters most. And if you can invest enough to at least get your employer match then definitely do that.

Once you complete the important first step of opening your retirement account — or any investment account — you also will need to choose what type of vehicle you want to invest it in. Soon I’ll write a post breaking down the differences between investment vehicles such as CDs, bonds, stocks, mutual funds, and index funds.