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What I want to do with this video
is to talk a little bit about 401(k)s,
Which you probably at minimum have heard of,
and just from the get-go, just to put some structure
in your mind of what this really is,
is it's very similar to a traditional IRA.
And the ways that they're the same is that you defer your taxes.
So you put money in on a tax deferred basis,
Let me put it this way, you put untaxed or you put
pre-tax money in, the money can grow inside of
either the 401(k) account or the traditional IRA account
untaxed. Let me write that.
Money grows in account untaxed, and then you can
withdraw it, you can withdraw the money
or start getting distributions from the account
after age 59 and a half.
So that's essentially when you're gonna start retiring,
when you're gonna need the money.
And when you withdraw after the age of 59 and a half,
you will then pay income tax.
And this is what people are talking about
when they talk about deferring taxes,
you're not getting out of the taxes,
you're just pushing off the date that you're going to have to pay the taxes.
And for a lot of people this might be useful,
because while you are making money, you might be
paying at a fairly high incremental tax rate,
but then once you're retired, you'll have a much lower one
I guess you be in a much lower incremental tax bracket
So your total overall tax bill might be lower.
Also maybe something happens just in terms with what the government does
in terms of how they charge taxes.
And in general, if you have to pay 50 cents
20 years in the future versus 50 cents today,
just present value of money tells you that
that 50 cents is going to be worth a lot less in the future,
or the present value is a lot less.
So that's some reason to defer, but of course,
you're not paying, you're not just gonna pay on what you put in
you will then also pay income tax on what you put in
and whatever grew, so you will pay income tax on total
on total dispersals.
And in both cases you have to start taking despersements
from your account by 70 and a half,
so penalties, let me write it this way:
penalties if you don't withdraw, or you don't
start withdrawing some of your funds by
70 and a half. And there are some special cases
if you're working and all these type of things.
Now, what happens if you withdraw
before age 59 and a half?
So so far everything I've listed is true of both
401Ks and traditional IRAs,
if you withdraw before 59 and a half,
you are taxed on withdrawal and,
on top of that, there's a
10% penalty on all the funds you receive.
And this is what you have to think about
unless you know if you just say,
I'm just always gonna max out my traditional IRA or 401(k),
you've gotta make sure that you're want that money
before 59 and a half, because you might be facing
this 10% withdrawal. So these are all the cases
that they are the same, so the question is,
why do they both exist? Why is there something
called a traditional IRA, and why is there something called a 401K?
They both seem like a pretty good way for me to
defer taxes, get earnings on income on my investment
in a tax deferred way and then pay at some future date,
and they both kind of force me to make sure they
strongly suggest that I shouldn't take out my money
before 50 and a half. So the ways that they're different
so let's focus on the differences,
so the differences between the two.
One is 401(k)s have a higher limit,
and if you're focused on 2010 but these numbers keep changing,
in 2010 the 401(k) limit is $16,500
and that's for just what you contribute to your 401(k)
while the IRA limit is $5,000.
This is an IRA. So one,
401(k) you can just participate with more money,
so actually in both of these cases,
as you approach your retirement, so after the age of 50
So let me put that in the same thing so that we're comprehensive,
so another similarity is that you can accelerate
some of your, or you can have higher I guess
deposits into your account.
Accelerate after 50, which just means you can put more money
than these limits than what I have right here.
So these are your limits before 50,
after 50, between 50 and 59 and a half (when you can start withdrawing)
you can put a little bit more money,
and these are constantly moving targets,
but the general idea is that you can put more money inside of a 401(k).
Now, the other difference is that a 401(k)
tends to be organized by your employer.
401(k) organized by employer.
And just from your point of view, that means two things:
one is, the employer will often specify the investments,
So they'll actually run the 401(k) account for you
Normally they'll be held by someone else,
but it will be for your company,
for company x, and the company gets to decide
the universe of investments that you will be able to invest in,
and the other thing, because it's run by the employer,
the employer might match, which means for every dollar you put in,
they'll put another dollar, even though they might go
above matching, actually I think the current limits
are approaching $50,000 for the total of the employee
and employer match. So you can actually get a lot of leverage
from putting in to a 401(k) if you have a very
generous employer. And the other difference
and this is really kind of a superficial difference
because it's just what you see, is that with a 401(k)
the money will be taken out of your paycheck,
you will never see it, so taken out before paycheck.
While with a traditional IRA, you will take the money
invest it into an IRA account, and when you report your taxes,
it will be reported as a tax deduction,
so you won't have to pay taxes on it.
Functionally they're the exact same thing.
So you think about the pros and cons, if you have a 401(k)
the option is available to you, it's a pretty good option.
You're going to have a higher limit right over here
and your employer might match it.
And then the other thing, and this doesn't come into place a lot,
but there's also the option of borrowing from a 401(k)
without penalty. Borrowing from a 401(k),
but you have to pay back interest to the 401(k) if you did that,
and you cannot do that with a traditional IRA.
Now when you're looking at this, well, why would anyone want to do a traditional IRA
well there's a couple things, one could do both,
or the other thing is traditional IRAs
you have much more flexibility on where you want to invest,
maybe your company says you can only invest
in us, you can only invest in that company's stock,
while in traditional IRAs you can invest in anything
But, hopefully that clarifies things a bit for you.
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