If you don’t know the difference between a 401k and an IRA, don’t panic! Paula Pant of Afford Anything breaks down financial jargon into terms any Grownup can understand.
If you hate talking about money, you’re not alone. Plenty of people, from Millennials to Baby Boomers, would rather talk about politics, religion, or even baby-making than discuss their bank balance.
We’re raised to think that discussing money is impolite and taboo. It’s a “don’t ask, don’t tell” subject. And because it’s off-limits, we figure money must be inherently bad or shameful. “Money is the root of all evil,” we’re told; “I’d rather be happy than rich.”
Our avoidance of the topic is compounded by the fact that we don’t understand money management. Personal finance feels overwhelming, complex, and scary. We suspect we’re not doing it right, but we have no idea what “doing it right” looks like.
We may get ambitious and try to figure it out (which, let’s be honest, means turning to Google). But then we’re hit with a tidal wave of articles by financial gurus throwing out all sorts of fancy jargon that just makes things even more confusing. 401k? IRA? WTF?
It’s enough to make you want to curl up on the couch with a Netflix marathon and forget the whole thing exists. (House of Cards, anyone?)
Finances Don’t Have to Be Hard (We Promise)
If the world of money management feels cold, far away, and like something you just can’t fathom, we’re here to help.
Let’s break down some money concepts into words the average human being can understand. With all the jargon deconstructed, you’ll find these concepts aren’t difficult at all. You may even be surprised to find the world of finance is actually kind of fun and empowering.
(OK, so it’s probably not as fun as watching Crazy Eyes do her thing on Orange Is the New Black, but still, it’s cool to realize that something that once seemed impossible is totally within grasp.)
Ready? Here we go…
Breaking Down Financial Jargon
The finance world loves buzzwords. And if you don’t understand them, it can feel like being behind a luxury SUV in traffic with one of those pretentious vacation spot abbreviation bumper stickers. (You know that driver knows you have no idea where “OBX” or “HH” is, but they want to show off the fact that they belong to a fancy social world and you don’t.)
But money management doesn’t feel like an old boys’ club. Once you get behind those abbreviations, the concepts themselves are simple enough.
Let’s dive into the lexicon of retirement jargon, one of the worst offenders when it comes to buzzwords, and also a category you’re probably not thinking about all that much because retirement seems so far away right now. (Now is actually the perfect time to start saving, because the longer your money stays invested in the markets, the more your money has a chance to grow. Just sayin’.)
Here are some retirement terms you’ve likely seen tossed around, and what they really mean.
Tax-Advantaged Retirement Accounts vs. Taxable Retirement Accounts
Tax-Advantaged Retirement Accounts
When a retirement account is tax-advantaged, that just means you get a benefit—an advantage—you don’t get with other accounts. This advantage could be anything. More often than not, it means the account is tax-deferred or tax-exempt (terms we’ll get to in a second).
“Tax-advantaged” is a really just broad umbrella statement that means the account gives you a tax benefit. With a taxable account, on the other hand, you don’t have an advantage, so tax-advantaged accounts are always better than regular old taxable accounts.
(See how ridiculously easy this is?)
Tax-Deferred Retirement Accounts
As the names imply, if a retirement account is tax-deferred, then you defer (or procrastinate on) paying the taxes until a later time.
For example, if you put $5,000 into a tax-deferred retirement account, you don’t have to pay income tax on that $5,000 now—and, as the money grows, it grows tax-free. But when you finally withdraw it (e.g., when you’re retired), then you pay taxes on it. That’s why it’s called “deferred”—the taxes will get paid eventually, but not right away.
Tax-Exempt Retirement Accounts
If an account is tax-exempt, then you pay the initial income tax on your contributions, but you are exempt (or excused) from paying any taxes on the growth that happens to those funds while they’re in the account. And when you withdraw it, you won’t have to pay taxes on any of the capital gains or dividends, either.
401k Retirement Accounts vs. 403b Retirement Accounts
A 401k is a tax-advantaged retirement savings account that’s set up by your employer. (If you’re self-employed, you can set one up for yourself.) That’s all it is, really: an employer-sponsored retirement savings account. “401k” is just a stodgy, boring way of saying that you have a tax-advantaged retirement account provided by your boss.
401ks can either be traditional or Roth. A traditional 401k is tax-deferred; a Roth 401k is tax-exempt.
A 403b is like a 401k except that it’s available to people who work for nonprofits, educational institutions like schools, and similar service-related organizations. It’s effectively the same thing as a 401k. (Both 401ks and 403bs are named for two different sections in the tax code, if you’ve been wondering where the random numbers come from.)
Individual Retirement Accounts (IRA)
An IRA is another type of retirement savings account. The “I” in the IRA is what matters here; it stands for individual, meaning you set up this retirement account yourself, rather than having one created for you by your boss.
With an IRA, you have more flexibility. Since it’s yours (tailored for the individual), you can choose any brokerage you want and you have more investment options within it. As with 401ks, your IRA can either be traditional (tax-deferred) or Roth (tax-exempt).
Have you stuck with us to this point? That wasn’t so impossible to understand, was it? And that’s about as hard as it gets.
Learning the basics of financial planning is just like learning a foreign language. First you start with the vocabulary, learning what each individual word or phrase means, and then you start stringing them together to understand more involved concepts. Pretty soon, you’re talking about the difference between HSAs and FSAs at cocktail parties and impressing the heck out of your less financially savvy friends.
(Disclaimer: HSAs and FSAs are probably not the most enthralling topics to introduce in a casual party setting, especially if you’re trying to get a date.)
If you can follow the basic family lineages in Game of Thrones, remember the lyrics to Top 40 pop songs, or hold a dictionary’s worth of social media abbreviations in your head, then you can absolutely hold your own in the financial world. The more you know, the more you’re able to make your money work for you.
You got this. Now go forth and impress your friends!
Paula Pant quit her 9-to-5 job, traveled to 33 countries, launched a business she runs from her laptop, and uses the profits to invest in real estate. She shares details about these adventures and more on her website, Afford Anything.
Any third-party resources or websites referenced above are not under Society of Grownups control. Society of Grownups cannot guarantee and are not responsible for the accuracy of the resources, websites, or any products or services available through such resources or websites.
While Society of Grownups hopes the information is useful, it’s only intended to provide general education. It’s not legal, tax, or investment advice, and may not apply or be useful to your specific financial situation. If you need recommendations geared to your personal financial situation, schedule time with a financial planner.