Understanding the Retirement Jargon

Hopefully, you work for a company that allows you to contribute to a 401k or 403b. Unless you work for the government in some capacity, or you are a nurse or teacher, you probably aren’t working in an environment that has pension or benefit plans. What is the difference?

What to do if your place of employment doesn’t offer one of those aforementioned plans? Someone at your bank asked you about opening an IRA; you have some vague understanding that your parents are bequeathing you mutual funds.

You just graduated from school last year, why are you already being told about these things? You are in your 40’s and only have the 403b’s that you have contributed to during your nearly 15 years in the nonprofit sector; are you going to be spending your retirement working as a greeter at Walmart to ensure you can make ends meet?

Alphabet Soup

Most full-time employees have the option of some type of retirement account to which they can contribute, the two biggest one being a 401k or a 403b.

Keeping straight all of the letters and numbers and abbreviations can seem like a job in and of itself, let alone understanding the differences between them. When it comes to retirement savings, particularly ones offered by employers, a 401k is the one most often talked about.

It was probably even one of the incentives offered by your current place of employment. But, what exactly is it? A 401k is a retirement plan offered by many employers that came about in the 1980’s after the cost of maintaining pension plans became too costly.

Pre-tax, employees can contribute a percentage of their paycheck to a 401k, and their employer will match that amount, up to a certain amount. (Typically, the amount an employer will match is 3%.) For example, if you earn $100,000 a year and you contribute 3% pre-tax, that is $3,000, with your employer contributing another $3,000.

You are free to contribute more than that, but your employer won’t match your contribution above 3%. However, if you are over 49 years old, you can contribute another $5,000, annually. The monies contributed are invested in mutual funds, which are comprised of any combination of stocks, bonds, and money market accounts.

As get older and perhaps want more conservative investments, you will need to contact whomever the administrator of the fund is, usually a company like Met Life or Fidelity, not the companies Human Resources department; while this may seem like a nuisance, it actually makes things easier, should you leave the company, but keep your investments where they are. Sounds like a pretty good set-up, yes?

It is, however, 401k’s also come with a lot of restrictions and caveats as to when you can access your funds. While you can access any money that you contributed, at any time, the amount of your employer’s contributions that are accessible are based on the length of your employment, which is called being, “vested”.

This is often used as motivation by employers to keep employees from leaving after only brief periods of employment. Additionally, there can often be penalties associated with withdrawing funds before retirement age. Lastly, remember: as the monies contributed were done so, pre-tax, when you do ultimately begin drawing funds from your 401k, you will be paying taxes on that income.

Another retirement account offered by employers is a 403b. This is generally offered to nonprofit and public education employees. It’s similar in many ways to a 401k, although you may find that if you are working for a small nonprofit organization, they do not offer a matching contribution.

Additionally, the administrative costs of a 403b are usually lower than that of a 401k, which means that you will probably be paying less in fund administrative fees. Should you have a 403b, you will also have many of the same restrictions regarding penalties for early withdraw, but you may have a greater allowable annual contribution. Much like a 401k, most 403b also allows for employees over 50 to increase the percentage of the contribution.

As with both a 401k or a 403b, there is no need to panic if your company or organization faces trouble and goes under. As the funds are managed by an outside entity, the money is still there for you. In some cases, the plan may be terminated, but all that means is that you will have the option of going ahead and taking the funds (again, paying taxes on it), or rolling it over into another type of account, such as an IRA.

When to Start

The biggest question, however, isn’t often regarding the similarities or differences between the two; rather, it’s, “how much should I be contributing?” As much as you can while still being able to pay bills, reduce debt and have the quality of life. Definitely contribute as much as your employer will match, otherwise, that is just money that you are leaving on the table.

As for at what age you should start saving for retirement, as obvious as it sounds, the sooner the better. Not only will you have more time to save, you also want to account for inflation. For example, something that cost $100 in 1958 now costs almost $800.

Ideally, if you can, start saving at age 25 at 15% of your annual income. This is the best formula for ensuring that you will be able to maintain your lifestyle in your Golden Years. But, if you are coming late to the party, there’s no need to panic. While increasing the amount you are saving each year may mean having to cut some corners today, it will serve you well once you reach retirement age.

Photo by Arnel Hasanovic on Unsplash

Previous article11 Ways to Recession-Proof Your Stock Portfolio
Next articleSavings Hacks for New College Students


Please enter your comment!
Please enter your name here

This site uses Akismet to reduce spam. Learn how your comment data is processed.