Since the 1980s, American retirees have needed to rely more on their own investments for retirement, rather than employer pensions or social security income. While pension plans still exist they are rare outside of the public sector. Another aspect of retirement planning for most is Social Security income, which isn’t enough for most retired Americans’ to live on.

This creates an increasing emphasis on individuals to invest for retirement using other methods. For a majority of people this means an IRA and a 401(k).

The opinions of the writer don’t necessarily express the opinions of Maine-OK Enterprises, Inc. or its publications: the Penobscot Bay Pilot, Boothbay Register and Wiscasset Newspaper. 

Neither Max Provencher nor the staff and contributors of Maine-OK Enterprises, Inc. or its publications – the Penobscot Bay Pilot, Boothbay Register and Wiscasset Newspaper – are licensed financial advisors. 

Licensed financial advisors should be consulted before any investment actions referenced in this opinion article are executed. 

Both the IRA or individual retirement accounts and the 401(k) are special accounts that offer tax savings advantages compared to a regular investment account. These accounts are designed to help people invest for retirement without taking on the full tax burden of capital gains from asset appreciation.

The main difference between the two is that an IRA is independent of your work while a 401(k) is sponsored by your employer.

You can open an IRA at any time with most major brokerages while a 401(k) must be opened and managed through your employer.

IRAs are constant and don’t require changes if you change jobs, however the process for changing or rolling over a 401(k) to a new employer can be complicated and expensive. Employees also have the option of keeping the old 401(k) instead of rolling it over.

Fees tend to be higher for 401(k) accounts and usually offer less investment options, but this differs based on who manages the plans for your employer.

A major benefit to 401(k) plans is that they allow employers to match employee contributions, this is in essence free money from your employer.

Both plans require that contributions be made from earned income rather than investment or other types of income. Both plans also require participants wait until 59 ½ to begin withdrawals. Early withdrawals may be subject to penalties and additional taxes based on income and account type.

In the case of both the IRA and 401(k) money put into these accounts is considered to be pre-tax, meaning that you won’t pay tax on any income that you direct towards the account. However, the downside to the traditional IRA and 401(k) is that you are still required to pay the full capital gains taxes at the time of withdrawal during retirement.

An alternative to the traditional IRA and 401(k) is the Roth IRA and Roth 401(k). These accounts allow you to contribute to them with after-tax money and withdraw the money during retirement tax-free.

Both the traditional and Roth types of both accounts have yearly contribution limitations. The IRA and Roth IRA both had a contribution limit of $6,000 ($7,000 if you're age 50 or older) for this fiscal year. The 401(k) and Roth 401(k) have a higher contribution limit at $19,500 ($26,000 if you're age 50 or older).

In addition to contribution limits some retirement accounts have income limitations. In the case of the traditional IRA there is no income limitation, however depending on income and filing status the tax benefits of using an IRA may become partially deductible or not deductible at all. The Roth IRA however, does have strict income limitations that prevent individuals who make more than the cutoff from contributing.

Unlike the IRA and Roth IRA, there are no income limitations on either the Roth or Traditional 401(k), however there are limitations to how much income is eligible for employer matching.

All four account types are not exclusive and savvy investors could have all four types of accounts. The caveat here is that the total contribution limit remains the same for both types of accounts so having all four would not increase your contribution limit.

Although I only mentioned the 401(k) and IRA there are also other types of retirement accounts that apply to self-employed business owners (SEP IRA) and certain public employees, as well as non-profit employees (403(b) Plans). There are retirement accounts that fit your situation regardless of income or type of employment, so there really is no excuse to not take advantage of them.

The world of retirement accounts is complex and confusing. Income limits, contribution limits, and other aspects of the accounts change yearly and are often changed by legislation. It is important to stay up to date on the latest changes to both types of plans so that you can maximize your retirement savings.

These accounts are not just limited to people in their 40s and 50s. I recently opened a Custodial Roth IRA with Fidelity as a 17-year-old. It’s never too early to get started and the most important thing you can do in your 20s is to simply get started.

Max Provencher is a senior at Searsport District High School. He currently serves as the Chapter President and founding member of the Searsport Future Business Leaders of America, Vice President of Maine FBLA, and serves as the FBLA National Treasurer. He helps to promote business education and financial literacy to over 200,000 members across the globe. Max is an avid investor in stocks and bonds, and works hard to promote financial literacy in schools as a member of the Maine DOE Student Cabinet. In his spare time he enjoys playing golf and running with his Airedale terrier, Ginger.