Spurred by this thread.
I never realised that what is called ‘Social Security’ in the States, is fairly similiar in intent to Superannuation.
I had thought that’s what a 401k was for. To provide money for retirement.
So is the 401k just an individial ‘top-up’ to social security benefits?
A 401 (k) is a plan under which you save for your own retirement. You have an account, put money in while you’re working, invest it somehow (like in mutual funds) while it’s in there, and take money out when you’re retired. Specifically a 401(k) plan is such a plan sponsored by a private-sector employer for its employees. A 403(b) plan is more common for public-sector employees.
An IRA or a Roth IRA is a plan you set up for yourself, without employer sponsorship. The difference is that for an IRA you pay into it with pre-tax income and then pay taxes when you draw it down during retirement, while a Roth IRA you pay into with post-tax income and draw downs are tax-free later on.
Even if no politician buggers up social security between now and when you retire, it’s not exactly a lot of money to live on. If you want to retire rich, you’ll want one of these plans.
Social Security is a semi-compulsory system that any worker pays into, and can potentially get the benefits when they reach a certain age. There are exceptions, and some professions are exempt to paying.
401(k)s are provided by private businesses where the employee pays in some of their income pre-tax into an account. Often times, the employer “matches” a certain percentage, so it’s “free money” (that you can’t touch until you’re older). Employers are under no obligation to offer a specific plan, and there are IIRC employee-size limitations.
Self-employed individuals may use and offer to their employees a SEP or SIMPLE plan. Employees of educational facilities (at least up to secondary school) have a 403(b) plan. Government employees get 457 plan. The general idea is the same as 401(k).
Social Security isn’t a valid retirement plan for the majority of people. It isn’t nearly enough money to sustain a lifestyle resembling a working person’s on its own. The maximum social security benefit is currently less than $2400 a month but that is the maximum and the amount a person gets depends on their salary history and how much they paid in but the overall cap is very low.
401K plans are tax advantaged retirement funds usually set up by employers that allow employee contributions up to some maximum percentage of salary. The employer often gives a contribution as well based on the employee’s contributions. A dollar for dollar employer contribution is reasonably common but it is sometimes more and sometimes nothing. The person who holds the 401K plan can move it between employers and usually has some say in how the money is invested in the form of a menu of choices like stock, bond, and mutual funds. All things considered, it is a great way to build up a retirement account when you take employer contributions and the tax advantages into account. You couldn’t just invest the money on your own and expect to do nearly well but there are serious restrictions on how you can use it. You can’t just tap into it anytime you want like you could with a savings account but you can make loans to yourself.
401K plans are only one of several of those types of accounts that exist in the U.S. although they are among the more common. There are others like 403b plans and IRA’s (Individual Retirement Accounts). Anyone can have the latter but they were designed for people that may be self-employed or work for an employer too small to offer a 401K plan. On top of those, there are still various pensions still around for some types of employees although they are rare for younger workers in the private sector.
You basically have to combine Social Security with the other types of plans to plan for a responsible retirement. People of my age (younger than 40) are told to be very skeptical that Social Security will exist in any reasonable form if and when we can retire so we have to come up with a way to fund it ourselves either through tax advantaged plans offered by an employer or by private investing on our own.
Good answers so far. I want to illuminate one additional point.
Once upon a time, retirement was really only provided at all in the form of pensions. You worked so many years, so you got a lifetime payout at retirement of $x. Social Security was set up that way as well. One nice perk to this system is that the employee knows exactly what the benefit will be and therefore they are often called defined benefit plans. One disadvantage to this system is that the employer bears significant risk and cost to set up the plan. Typically, pensions are funded with current dollars that are meant to grow as investments to meet future obligations. But if the market underperforms, the company can be left with insufficient money to pay the pensions. Then there are problems of companies under-contributing or going bankrupt altogether. Another problem is that it’s not very attractive to offer pensions to part-time or short-term workers because the amounts would be very small (imagine a $50/month pension earned during your one year at MegaCorp Inc). This became an increasing problem as job mobility increased and workers went from 20 years with one employe to only 5.
So one solution is to set up a plan where the employee receives money from the company now rather than a pension fund receiving the money now. The employee invests that money and the employee nows bears the risk (and potential reward) of market performance. The employer has no obligation for benefit amounts at retirement. The result is a defined contribution plan because the employer is only setting their contribution level. Employers like this because they understand risk and employees like it because they don’t understand risk. It gives employees an easy way to sock away additional money on top of what the company offers (elective deferrals of up to $16,500 a year for 401ks). In any event, it’s a perfect solution for small contributions - a company can give you $100 now without any further obligations, and you can take that $100 and combine it with contributions from other employers past and present.
401k refers to a specific section in the Internal Revenue Code. And you’ll guess correctly that 403b and 457 are other section references.