Money Rehab with Nicole Lapin - 401(k) vs Traditional IRA vs Roth IRAs: Which Retirement Account Is Best For Your Goals

Episode Date: March 6, 2024

401k... IRA… alphabet soup… help? Nicole breaks down the difference between the darlings of the retirement world, and how to know which option is right for you. Here's the info on the Robinhood boost Nicole mentioned: Robinhood has the only IRA that gives you a 3% boost on every dollar you contribute when you subscribe to Robinhood Gold. Terms and conditions apply. Learn more at Robinhood.com/boost  Here's the episode Nicole mentioned that explains the perfect legal loophole you can use to snag a Roth IRA

One of the most stressful periods of my life was when I was in credit card debt. I got to a point where I just knew that I had to get it under control for my financial future and also for my mental health. We've all hit a point where we've realized it was time to make some serious money moves. So take control of your finances by using a Chime checking account with features like no maintenance fees, fee-free overdraft up to $200, or getting paid up to two days early with direct deposit. Learn more at Chime.com slash MNN. When you check out Chime, you'll see that you can overdraft up to $200 with no fees. If you're an OG listener, you know about my infamous $35 overdraft fee that

I got from buying a $7 latte and how I am still very fired up about it. If I had Chime back then, that wouldn't even be a story. Make your fall finances a little greener by working toward your financial goals with Chime. Open your account in just two minutes at Chime.com slash MNN. That's Chime.com slash MNN. Chime. Feels like progress. Banking services and debit card provided by the Bancorp Bank N.A. or Stride Bank N.A. Members FDIC. SpotMe eligibility requirements and overdraft limits apply. Boosts are available to eligible Chime members enrolled in SpotMe and are subject to monthly limits. Terms and conditions apply. Go to Chime.com slash disclosures for details.

I love hosting on Airbnb. It's a great way to bring in some extra cash, but I totally get it that it might sound overwhelming to start or even too complicated if, say, you want to put your summer home in Maine on Airbnb, but you live full time in San Francisco and you can't go to Maine every time you need to change sheets for your guests or something like that. If thoughts like these have been holding you back, I have great news for you. Airbnb has launched a co-host network, which is a network of high quality local co-hosts with Airbnb experience that can take care of your home and your guests. Co-hosts can do what you don't have time for, like managing your

reservations, messaging your guests, giving support at the property, or even create your listing for you. I always want to line up a reservation for my house when I'm traveling for work, but sometimes I just don't get around to it because getting ready to travel always feels like a scramble, so I don't end up making time to make my house look guest friendly. I guess that's the best way to put it. But I'm matching with a co-host so I can still make that extra cash while also making it easy on myself. Find a co-host at Airbnb.com slash host. I'm Nicole Lappin, the only financial expert you don't need a dictionary to understand. It's time for some money rehab. These days, we have a whole lot of choices when it comes to investment vehicles for retirement.

Back in the day, it was only Social Security, Medicare, and pensions. That's it. Today, there are at least eight different kinds of benefits plans that you can choose from, but that is a huge responsibility. So how do we make this decision? Money Rehabber Charlie sent in this question. Hey, Nicole, I'm honestly just completely fucking lost when it comes to retirement plans. Most of my friends have a 401k, but my brother has a Roth IRA and feels so strongly about it. Which one is better? And how do you know they're different? right and feel so strongly about it. Which one is better? And how do you know they're different? Okay, Charlie, I know that the alphabet soup of retirement accounts can feel so overwhelming, but I'll take you through all of it. I'll give you the big retirement players and then the pros and cons of each of them. But I'm going to start by giving you a guiding principle, a North Star, if you will, to keep in mind as you're learning more about your options. Here's your North Star.

You're going to need more than one kind of retirement account in order to ball out in your senior citizen years. This picture is going to start to come into focus as I go through the big retirement players, but just keep this in mind as we go. You're not going to choose which account, but which combination of accounts are best for your goals. Okay, let's meet the contestants. which combination of accounts are best for your goals. Okay, let's meet the contestants. Let's start with the account your friends are stoked on a 401k. A 401k is a retirement account established by employers for employees. If you're at a company that offers a 401k, you can make contributions

before the money hits your paycheck and your contribution is invested in an account with your name on it. People get really excited by 401ks because sometimes an employer can make a matching contribution to your account, which is like free money. It's not always the case, but when it happens, we love that. Another cool characteristic of 401ks is that your contributions are pre tax, meaning these contributions get taken from your paycheck before your income is taxed. However, don't think of this money as tax

free because you do have to pay tax when you take the money out. And if you take it out before you're fifty nine and a half. Yes, that is the actual number the IRS came up with. You have to pay penalty fees. But let's do a little myth busting here. 401ks aren't and were never intended to replace your income when you retire. It's just how we started using them once traditional pensions, which are meant to replace your income when you retire, started becoming less and less common. Pensions would guarantee your

money when you retired, and that put the burden on your employer to make sure the money was there when you needed it. Nowadays, 401ks are cheaper to run for employers, and they put the burden on you. However, again, let's go back to the North Star. 401ks are not the new pensions. There isn't an amount of money that's guaranteed to be in your 401k by the time you retire, so you will likely need more than one retirement account in order to live a rich full life in retirement. Okay, rant over. Regardless, 401ks do tend to be the most popular retirement plan, but that doesn't mean they're best for you. Remember, trusting your employer with your money is trusting your employer with your money. Why not trust yourself instead?

Most people don't realize that 401ks are technically profit-sharing accounts, which means that 100% of your contributions can be invested in your company's stock. Which you should never do because it's generally a really bad idea to have your money in one company because if that company were to go under, you'd lose your retirement nest egg. Hello, WorldCom, Tyco, Enron, I'm looking at you. Maybe it's just me, but the basic idea of having your retirement and your job being so closely linked seems wrong. If you put all of your money in your company's stock and the company goes out of business, your livelihood is doubly screwed.

Now, with losing your job, and later, with losing your retirement savings. Let's review, checklist style. A 401k is right for you if, number one, your employer matches your contributions. Number two, you need something easy or you won't save it all. No shame if that's you. Number three, you want to go crazy with your contributions. The contribution limit for a 401k in 2024 is 23 grand for your personal contributions. That is much higher than an IRA, which we will get to in a sec. Number four, you might need to borrow from yourself. There are a few different circumstances where you can take money from your 401k with no or fewer penalties, like if you're a first-time

homebuyer or if you have a medical issue. Or you can take out up to 50k or 50% of your balance, whichever is less, if you need to pay for an emergency without a penalty, so long as you pay it back within five years. Side note here, try your hardest not to exercise this option, especially if you have a precarious work situation, because if you lose your job, you have to pay what you borrowed back within 60 days, or it will be considered a default and hurt your credit score big time. Plus, this isn't an interest-free loan here. You're going to have to pay interest, and the interest rate will be on the higher side. The good news is that you're paying this interest to yourself. But still, I wouldn't use this option unless you absolutely had to.

But know that it is an option. Now, the flip side. A 401k is a good retirement option, but you might want to think a little more critically if you check any of these boxes. Number one, you don't have six to nine months of emergency reserves in the bank. Yes, you need to save for retirement, but you need liquidity first. You can't go to the grocery store and pay with your 401k. Number two, your employer doesn't match your contributions. Many do, but not all do. So check many companies to spend 401k matching contributions as a cost saving measure if the company is going through a hard period.

So definitely keep an eye out for that. And if your company does suspend 401k matching contributions, be aware because sometimes that's a precursor to layoffs. Number three, you have a significant amount of credit card debt. Paying down debt is a form of long-term savings because if you don't pay it down now, you'll pay more and save less later. Avoid the potential avalanche of debt and tackle the mountain of interest-accumulating bills first. 4. You want freedom of choice on fees and investment options

Since this is your employer's show, they pick the plan and the fees. You get a few options, but that's it. Even if the fees seem small at the time, they definitely add up, so you might be able to do better if you feel adventurous and studious enough to tackle it on your own. While you think over whether 401ks are a good match for you, pun intended, let's introduce our next candidate, the traditional IRA. IRA stands for Individual Retirement Account. Similar to a 401, you can open a traditional IRA with pre-tax money and you don't have to worry about paying tax on that money until you use it for retirement. But unlike a 401, an IRA is not offered through your employer. You set it up

yourself. You keep that account forever and always, no matter where you work. Hence, the individual part of individual retirement account. IRAs are all the rage these days. But how do these darlings of the retirement savings world work? I found out by opening one myself. When I was at CNN, I started a 401k because it was recommended to me. I never stopped to consider my options. Now I wish I had earlier, so please live and learn from me. Hold onto your wallets. Money Rehab will be right back. One of the most stressful periods of my life was when I was in credit card debt.

I got to a point where I just knew that I had to get it under control for my financial future and also for my mental health. We've all hit a point where we've realized it was time to make some serious money moves. So take control of your finances by using a Chime checking account with features like no maintenance fees, fee-free overdraft up to $200, or getting paid up to two days early with direct deposit. Learn more at Chime.com slash MNN. When you check out Chime, you'll see that you can overdraft up to $200 with no fees. If you're an OG listener, you know about my infamous $35 overdraft fee that I got from buying a $7 latte and how I am still very fired up about it. If I had Chime back then, that wouldn't even be a story. Make your fall finances a little greener

by working toward your financial goals with Chime. Open your account in just two minutes at Chime.com slash MNN. That's Chime.com slash MNN. Chime feels like progress. Banking services and debit card provided by the Bancorp Bank N.A. or Stride Bank N.A. Members FDIC. SpotMe eligibility requirements and overdraft limits apply. Boosts are available to eligible Chime members enrolled in Spot Me and are subject to monthly limits. Terms and conditions apply. Go to chime.com slash disclosures for details. I love hosting on Airbnb. It's a great way to bring in some extra cash,

but I totally get it that it might sound overwhelming to start or even too complicated if say you wanna put your summer home in Maine on Airbnb, but you live full-time in San Francisco and you can't go to Maine every time you need to change sheets for your guests or something like that. If thoughts like these have been holding you back, I have great news for you. Airbnb has launched a co-host network, which is a network of high quality local co-hosts with Airbnb experience that can take care of your home and your guests. Co-hosts can do what you don't

have time for, like managing your reservations, messaging your guests, giving support at the property, or even create your listing for you. I always want to line up a reservation for my house when I'm traveling for work. But sometimes I just don't get around to it because getting ready to travel always feels like a scramble, so I don't end up making time to make my house look guest-friendly. I guess that's the best way to put it. But I'm matching with a co-host, so I can still make that extra cash while also making it easy on myself. Find a co-host at Airbnb.com slash host. And now for some more money rehab. When I finally did look into my other options, though, I found that there were three major pros of an IRA for me. Number one, the money I put in actually reduced my taxes. At the time I was in the 25% tax bracket, I think I contributed 6k to my IRA and when I did,

my taxable income was reduced by that amount. So that meant my tax bill was reduced by a cool 1500 bucks, 25% of 6k, and I love, love, love reducing my tax bills wherever I can. It's not that I saved the money per se because tax refunds are really just your money coming back to you, but I didn't have to pay more for it. Number two, I could still have a 401k and if I had enough money to max them both out, I could. Number three, like a 401k, there are circumstances where you can take money out of the account early without paying a penalty, like if youk, there are circumstances where you can take money out of the account early without paying a penalty. Like if you're using the money for medical expenses, to buy a house, or for educational expenses, you can skirt around the 10% penalty fee. By the way, you can make an

IRA contribution up to tax day following the year for which you're making the contribution. In other words, you have until April 15th of 2024 to make a contribution for 2023. While IRAs have a lot of pros, there is one notable con. You are limited by the amount that you can contribute each year. And the contribution limit is much lower than 401ks. In 2024, you could contribute $7,000

if you are younger than 50 and $8,000 if you were older than 50, which if you're younger than 50 is less than a third of what you can contribute to a 401k. Once you max out a traditional IRA, as you should try to do annually, the show is over until next year. So having a traditional IRA alone isn't going to catapult you into retirement rock stardom because an IRA is a little more DIY than 401ks. It might feel a little intimidating to start, but it's not. Here's how to get a traditional IRA up and running in just five steps. Step one, choose a brokerage you want to use for your IRA. You can call the companies directly or just go online. Some popular companies are Vanguard, Fidelity, Robinhood. I'm actually partnering with Robinhood right now.

And through April 30th of 2024, they're offering their gold members up to 3% extra on every dollar you contribute to an IRA. Terms and conditions apply, of course. So learn more at Robinhood.com slash boost or the link in the show notes. Step two, if you're calling someone at your brokerage, have them talk you through the account setup process. Also easily done online. Step three, fund the account, that is, put money into it and voila, you have an IRA, but you're not done. Step four, decide what you want to invest that money in. This is perhaps the most important step. Some people will just put money into their IRA and think it means their money is automatically invested. It is not. Unless you physically invest the money that's in that IRA, it is doing as much for you as your money is sitting in your checking account. So make sure you invest that money, put it to work. My investment strategy,

which as you know by now, is to index funds and chill. If you have any questions on which funds to invest in, I took a listener through this process on an episode which I also linked in the show notes. Step 5. Claim the amount you contributed as a deduction on your tax return. And scene. But wait, there is more. I've been saving the very best for last. The superstar of them all. Roth IRAs. This is what your brother is obsessed with, Charlie. Roth IRAs, or just Roths for short, are a lot like traditional IRAs,

except your contributions are post tax, meaning you fund the account with contributions you've already paid income tax on. So unlike a 401k or a traditional ira you don't have to pay tax on the money that you take out because you already paid it this makes your nest egg a whole lot easier to account for over time we can't see into the future we don't know what tax rates are going to be by the time you retire but tax rates are likely going to increase so those investing in a 401k or a traditional ira have an unknown tax bill looming while those with roths will have no surprises yes you will be paying taxes now on

what you contribute but you're paying it before your money has even grown when you pay taxes later like with the 401k or traditional ira you'll be paying taxes based on the amount that money has grown to. The rule in 2024 is that you're eligible for a Roth IRA if you make less than $161,000 as a single person or $240,000 for those married and filing jointly. So if you are given this option, you should absolutely put money into a Roth. Do not hesitate. Pause the podcast right now. Open up an account.

And if you do make more than these Roth ceilings, first of all, good for you. And second of all, there is a perfectly legal loophole here. I did a whole episode on this too, which I also linked in the show notes. I'll show you the money trail. Assume you have $80,000 in your retirement account when you want to take your money out decades from now with a traditional ira that 80 grand is all taxable as ordinary income that's the same tax rate you pay on the salary you make assume a 25 tax rate and the amount of money you really have after tax is sixty thousand dollars in other words you'll have to give 20 grand to the government before you can use it for all of the fun things you planned. With a Roth, though, you keep the full $80,000. That's right. You don't have to give 20 grand to the tax man when you retire because you already pay taxes on the money when you put it in the account in the first place. The only thing you

gave up to get this awesome deal was the tax deduction when you made the original contribution. You can't deduct Roth IRAs like you can traditional IRAs. Sticking to our assumed 25% tax rate, you paid an extra $1,500 of tax when you started 25% of 6K for the privilege not to pay $20,000 later. That is a very good deal. So do not pass up making Roth contributions if you can. For today's tip, you can take straight to the bank. If you run a small business or if you work freelance, you can still have a 401. If you are a self-employed person, you can open a solo 401,

which is best for business owners who have no employees. With this account, you can make the maximum $23,000 contribution, just like if you were a W-2 employee at a big Walmart-esque company. But as your own employer, you can also make matching contributions to your account. Every business is different, so you definitely want to do your research to determine whether or not this is a good fit for you. But just know that just because you're your own boss doesn't mean you can't get a 401k. Money Rehab is a production of Money News Network i'm your host nicole lappen money rehab's executive producer is morgan lavoie our researcher is emily holmes do you need some money

rehab and let's be honest we all do so email us your money questions money rehab at money news network.com to potentially have your questions answered on the show or even have a one-on-one intervention with me. And follow us on Instagram at Money News and TikTok at Money News Network for exclusive video content. And lastly, thank you. No, seriously, thank you. Thank you for listening and for investing in yourself, which is the most important investment you can make. you