What Is a Retirement Account?
A retirement account has special features that make it easier to grow your savings for the future. And by “special features,” we mean tax benefits. The main thing that differentiates retirement accounts from other types of savings and investment accounts is taxes.
The reason you hear a lot about retirement accounts such as 401(k)s and IRAs is that they give a big tax break to help you save for retirement. Depending on the account type, you’re rewarded with either an upfront tax break or tax-free withdrawals later on. And with all retirement accounts, you don’t pay any taxes while your money is sitting in the account.
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Retirement tax breaks
If you choose an account that offers an upfront tax break, like a 401(k) or traditional IRA, that means you don’t have to pay any income tax on the money you contribute to that account in the year you make the contribution. That tax savings is like extra money you find under the couch cushions: It can help you buy more things, and by “buy more” we mean “save more.” Plus, you don’t have to worry about taxes at all while your money is in the account. (Once you start taking withdrawals after you retire, then the IRS is gonna come knocking.)
If you choose a Roth account, such as a Roth 401(k) or Roth IRA, then you don’t get that upfront tax break but you do get something at least as sweet: No taxes when you take the money out in retirement. That means your money grows totally tax-free and you will not be hearing from the IRS when you start taking retirement withdrawals.
Still wondering if a retirement account is right for you? Here’s a side-by-side comparison of the basic differences between retirement, investment and savings accounts:
Features | Retirement account | Investment account | Savings account |
Available investments within account | Stocks, bonds, mutual funds, ETFs, etc. | Stocks, bonds, mutual funds, ETFs, etc. | Cash, money market funds |
Growth potential | Based on investment returns | Based on investment returns | Limited by APY offered by bank |
Offers a tax break on contributions or withdrawals | Yes | No (though capital gains rates are lower than income tax rates) | No |
IRS limits on contributions | Yes (based on account type) | No | No |
Investment gains | No | Yes, when an asset is sold | Yes |
Penalties for early withdrawals (before age 59 ½) | Maybe (some types of accounts allow penalty-free early withdrawals) | No (though gains are taxable) | No |
Requires minimum annual withdrawals after you turn 72 | Maybe (depends on the type of account) | No | No |
Best used for | Money you don’t plan to spend before age 59½ | Long-term savings (5+ years, depending on your risk tolerance) | Money you plan to spend in the next 0-5 years |
Bottom line: Saving for retirement is great. Investing for retirement is better. And investing for retirement with some help from the IRS? Priceless. If you’ve got a 401(k) or other workplace retirement plan, be sure to invest in that to secure any company match. If your company doesn’t offer a match, then open an IRA.
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