Definition: Retirement plans are portfolios and plans which are designed to accumulate resources to fund one’s retirement. Retirement plans fill a wide range—some are business (or “boss”) sponsored, some are individually managed, others are managed by advisors. The key retirement plans used by most investors are IRA’s and 401K’s.
IRA’s: Individual Retirement Accounts, or “IRA’s,” were designed to encourage people to save for their retirement. Anyone can open an IRA. IRA contributors (maxed at $5,500/year) are rewarded for this foresight by getting a tax-deduction for whatever monies they put into their IRA’s and tax deferment treatment (meaning any taxes on the monies they contribute to IRA’s are deferred—and thus allowed to accumulate tax free—until they make distributions from the IRA at retirement age (70&1/2)). Withdrawals prior to that age are subject to penalties.
Roth IRA’s are not tax deductable. Taxes on Roth IRA contributions are paid at the year of the contribution and thus no taxes are paid upon distribution.
Funds in IRA accounts may be used to buy stocks, bonds, mutual funds, ETF’s etc. You can create your own portfolio for the IRA or rely on advisors.
401K’s: 401K plans are retirement plans in which an employee directs his employer to deduct a certain percentage of his/her salary to a retirement account—often with the employer making matching contributions. Contributions to 401Ks (unless it’s a Roth 401K) are made with pre-tax dollars, which means distributions from the 401K will be taxed (as ordinary income).
Advantages: Depending on the structure, retirement accounts offer tax deduction and deferment advantages as well as potential matching contribution funding from certain employers, in the case of 401K’s.
Risks: Retirement accounts are still subject to market risk if they are linked to market portfolios.