Retirement Accounts

A 401(k) (through an employer) and an IRA (opened individually) are both containers, not investments. Inside either one, you still choose stocks, bonds, or funds — the same building blocks from two chapters ago. What the container adds is a tax rule: a traditional account reduces your taxable income now and taxes withdrawals in retirement; a Roth account is taxed now and qualified withdrawals in retirement are entirely tax-free.

Nothing about that mechanism is uniquely American, even though the names are. Whatever country you live in almost certainly has a version of the same trade: the UK pairs a workplace pension with a tax-free ISA, Canada pairs a pre-tax RRSP with a post-tax TFSA, Australia funnels retirement saving through superannuation. Different labels, the same three questions worth asking of any of them — what's the tax treatment, is there a match, and what does it cost to access the money early.

Say you earn an extra $100 and face a 22% tax rate. Contribute it to a traditional account and the full $100 goes in — no tax paid now — but withdrawals in retirement get taxed as ordinary income at whatever rate applies then. Contribute it to a Roth account instead and you pay the 22% first, landing about $78 in the account, but every dollar it grows into comes out completely untaxed in retirement, as long as the account's rules for qualified withdrawals are met.

If your tax rate is identical at contribution and at withdrawal, the two options land in the same place mathematically. The real decision is a bet on which direction that rate moves: expect a lower tax rate in retirement than you pay today and traditional tends to win; expect your rate to be the same or higher later — common for someone early in their career, likely to earn more over time — and Roth tends to win.

A common match structure is 100% on the first few percent of salary you contribute, then 50% on the next couple of percent. Contributing less than the full matched amount means walking away from money your employer would otherwise have paid you — not a missed investment opportunity, a direct pay cut you chose.

Treat the match as what it actually is: a 100% or 50% immediate return, guaranteed, on the dollars you contribute up to the match limit. No stock, bond, or fund in the previous chapters offers anything close to that on day one — the best investment available to most people isn't a clever pick, it's claiming the match in full before optimising anything else.

The match isn't always yours the moment it lands in the account. Vesting is the schedule that decides when employer contributions actually become yours to keep if you leave — your own contributions are always fully yours immediately, but the employer's match usually is not.

Check this before counting an employer match as guaranteed money, especially if a job change is on the horizon — the match shown in the chart above is the maximum available, and vesting is the condition attached to actually keeping it.

The tax advantage inside these accounts comes with a price for accessing the money early: in the US, withdrawing from most retirement accounts before age 59½ triggers ordinary income tax plus an additional 10% penalty on top, with a short list of narrow exceptions. That penalty exists specifically because the tax break was granted on the assumption the money would stay put for decades.

Everything from the compound interest chapter applies here directly — a retirement account is simply where that growth happens with a tax advantage layered on top. The same ten-year head start that mattered in a plain savings comparison matters here too, amplified by decades of tax-advantaged compounding on top of the match itself.