401(k), IRA, Roth: Retirement Accounts Explained Simply
The alphabet of retirement accounts is mostly two questions: is the money taxed now or later, and does your employer add anything? Everything else is detail.
Almost every retirement account answers one of two questions. Traditional accounts give you a tax break now and tax you at withdrawal. Roth accounts tax you now and let withdrawals be tax-free later.
The second question is whether anyone else contributes. An employer match is free money, and no investment decision you make will beat it.
The order that usually makes sense
- Contribute enough to get the full employer match. This is not a close call. An instant fifty or hundred percent return beats anything the market offers.
- Build a small emergency fund. A few months of expenses, so a surprise does not become new debt.
- Consider an IRA. Usually more choice and lower fees than a workplace plan.
- Go back and max out the workplace plan.
Traditional or Roth?
The honest answer is that it depends on your tax rate now versus in retirement, which nobody knows. A reasonable rule for most people early in a career, when income is lower, is to lean Roth.
The more important point is that the choice matters far less than starting. The difference between the two accounts is a few percentage points of tax. The difference between starting at 25 and starting at 35 is enormous.
What to buy inside the account
The default is often a target-date fund, which is a reasonable choice — it shifts from stocks to bonds automatically as you approach retirement.
If you prefer to choose, a broad index fund with a very low fee is the standard answer. Either way, leaving the money in cash inside a retirement account is the one thing to avoid.
The bottom line
Get the match first, then a small safety net, then a low-cost account. Traditional versus Roth is a smaller decision than it feels like. Starting is the decision that matters.
