Retirement jargon can feel foreign and confusing, but it’s necessary to understand when forming your retirement plan. In this article, we define common retirement terms and answer questions so you can feel confident and informed. Retirement doesn’t need to be more overwhelming than it already is. It’s essential to know what you are getting into before making any decisions. To start, we have outlined a few standard “Retirement 101” terms you need to know.
Individual Retirement Account (IRA)
The Merriam-Webster dictionary simplifies the definition of an IRA as, “A retirement savings account in which income taxes on certain deposits and all gains are deferred until withdrawals are made.” Any income-earning adult is eligible to open an IRA, making IRAs an accessible retirement planning vehicle. IRAs are especially helpful if you don’t have access to an employer-sponsored retirement plan such as a 401(k).
The two most well-known IRA types are traditional and Roth. The traditional option is an IRA in which investments grow tax-deferred, and contributions can be tax-deductible. With a Roth IRA, money grows tax-free, and withdrawals in retirement are also tax-free. It’s wise to seek education about all IRA options before deciding what’s best for you. The Retirement Industry Trust Association (RITA) offers Retirement 101 education, focusing on best practices for self-directed IRA retirement planning.
401(k)
A 401(k) is an employer-sponsored retirement savings plan offered to a company’s employees. Employers are not required to offer 401(k) plans, but many companies do. Some companies will even match a percentage of the amount you contribute from each paycheck. (You can get “free” money from your employer based on how much you contribute!) Employers can match a percentage of your contributions up to a set portion of total salary or contribute up to a specific dollar amount, regardless of your salary. To avoid paying early withdrawal penalties, an investor should wait until (at least) age 59½ to withdraw 401(k) money. Because rules about accessing your 401(k) plan after retirement are determined by both the IRS and the company that set it up, it’s best to consult your employer’s 401(k) plan administrator for details when approaching the age you plan to retire.
Tax-Deferred
Tax-deferred means that you don’t have to pay taxes on the retirement funds until later, often when you withdraw funds. The idea behind this is that, at a later time, you may be in a lower tax bracket and therefore owe fewer taxes.
Prohibited Transactions
Prohibited transactions are exactly what they sound like. Generally, a prohibited transaction in an IRA is any improper use of an IRA account or annuity by the IRA owner, his or her beneficiary, or any disqualified person. Some examples of prohibited transactions are:
- Borrowing money from the IRA
- Selling property to the IRA
- Using the IRA as security for a loan
- Buying property for personal use with IRA funds
Rollover
If you move your assets from one investment account to another, it’s called a rollover. This happens most often when an individual leaves a job with an employer-sponsored retirement plan. You can no longer contribute to that employer’s plan once you leave. However, that doesn’t mean you “lose” those savings. When you leave a 401(k) plan-sponsoring employer, you have a few options:
- Leave the money in the account set up for your former employer’s plan. You can no longer contribute to the account, but will still be able to access the funds for your retirement.
- Rollover the funds to an account on your new employer’s plan and take advantage of their benefits.
- Rollover the funds to an IRA. The main advantage of an IRA rollover is the consolidation of all of your retirement savings into one place, regardless of where you’re employed.
IRA Custodian
In general terms, a custodian is one who has custody and is therefore responsible for keeping something (or someone) safe and secure. When it comes to investing, a custodian is the financial services company that maintains records of financial assets or has physical possession of specific securities. For an Individual Retirement Account, the IRA custodian is the bank, brokerage firm, or other financial services company that holds your account. IRA custodians, also called trustees, are different depending on the type of IRA. For customer-directed (or self-directed) IRAs, a directed IRA custodian serves as a passive, non-discretionary custodian that executes investment directions from you, the IRA owner. A directed IRA custodian also performs the many custodial and administrative duties necessary to preserve the tax-deferred status of an IRA.
Retirement 101 FAQs
Now that you know a little more about standard “Retirement 101” terms, let’s address a few questions you might have:
At what age should I begin saving for retirement?
The short answer is now! You are never too young or too old to start saving for retirement. You should begin investing in your retirement as early as possible. The best strategy is to regularly contribute to a retirement account as long as you are financially stable enough to part with a portion of your income, albeit temporarily. You must also keep in mind that you generally cannot touch these funds before retirement without paying penalty fees. However, there are exceptions to this, including withdrawals for first-time home purchases, birth or adoption expenses, educational or medical expenses, disability, health insurance, and more.
How long will my money last?
There is no precise answer to how long your retirement savings will last. It will vary depending on the amount of money you’ve saved, the budget you’ve set for yourself, unexpected expenses that arise, and more. The SEC offers a helpful Ballpark E$timate worksheet to use as a starting point. However, for a more accurate number, your best course of action is to work with a trusted and certified financial advisor. They will help you determine how much money you will need during retirement while accounting for medical, emergency, and leisure expenses.
Do I need more than one retirement account?
Experts often recommend having both a 401(k) and an IRA in your retirement plan. This way, you can maximize your contributions to both accounts and enjoy more benefits and savings overall. If you have the financial resources to invest, it never hurts to plan for additional retirement savings.
Retirement planning can be a complicated process for anyone. Your main “Retirement 101” takeaway should be to always do your due diligence before investing and be aware of potential fraud. At RITA, we want you to feel informed, confident, and prepared for the future. Happy retirement planning!