First, lets address the very question posed to you in the “About” section. So if the answer to how is your retirement account invested ISN’T “in my 401K” or “in Fidelity” or some other company, then what is the right answer?
Retirement accounts are called all sorts of things like 401K, 401A, 457 and so on and we first need to understand what a retirement account actually is. Fidelity or some other provider is who manages your retirement account. They hold the money and manage the money you put into it and call title it as your 401K or whatever type it is. By the way, I only mention Fidelity because they are a huge company that most people recognize. There are numerous other companies out there. In fact, my retirement account isn’t even managed by them and I have no connection to them.
First, to clarify, 401K is the most common retirement account for corporate workers. 401A’s and 457’s are the most common retirement account for state or local government employees, which includes law enforcement.
They are all retirement accounts that have the same basic makeup with slightly different rules.
Think of a retirement account as an umbrella, your paycheck is a sugar cube and the IRS (tax man) is the rain. When you get paid your sugar cube, the rain falls on the cube and washes some of the sugar cube away. Now you are only left with part of your sugar cube. That’s what happens to your paycheck and why you were paid $1,000 but only see $750 in your bank account (these are not actual numbers, work with me here).
So when you put nothing into your retirement account the tax man took $250 ($1,000-$750=$250) of your paycheck (as I showed above). By taking, let’s say, $100 of your paycheck and putting it directly into your retirement account, none of that $100 gets taxed and you keep it all for now. Now the tax man can only wash away part of the remaining $900 of your paycheck because the other $100 was protected in your retirement account. So out of $900 you get to keep $675 in your bank account, plus the $100 which is saved for later (retirement). That means today you are only paying the tax man $225 instead of $250.
If properly invested that $100 will grow in your retirement account and when you are retired you can take the $100 plus what it earned out from the retirement account and at that time you pay taxes on it.
The point is, while you are working you might be in the 25%, 28% tax bracket or higher. If you are in a lower tax bracket when you are retired, say 15%, you will pay $15 of the $100 to the tax man instead of $25 or more when you were working.
Retirement accounts have all sorts of names but they are not the thing that makes the money grow. Inside the retirement account are different things that your $100 are invested in. The retirement account is just an umbrella that tells the tax man to keep out, for now.
The complicated part is the stuff inside your retirement account that your money is invested in. Those things need to be understood because some will make your money move up and down like it’s on a roller coaster and others will make your money move up and down like it’s on a casual stroll on a flat street.
So when you are asked where your retirement money is invested the answer is actually “the different things under the umbrella”. I wouldn’t give that answer because they will probably look at you like you’re an idiot but those things under the umbrella are where you really need to focus.
Retirement accounts have all sorts of names, 401K (for corporate workers), 401A and 457 (local and state government), TSP (Federal government), 403B (mostly school teachers and employees), IRA (for individuals, and not set up through your employer), SEP Plans (self-employed), and there are more.
There is also a word that can go on the front of it called “Roth” or a Roth 401K, Roth IRA and so on. These need a separate discussion because the “Roth” makes the umbrella work differently.