Financial Literacy: Retirement Accounts: 401(k) and IRA Basics
Understanding workplace plans, IRAs, taxes, matching, and long-term growth
Financial Literacy: Retirement Accounts: 401(k) and IRA Basics
Understanding workplace plans, IRAs, taxes, matching, and long-term growth
Financial Literacy - Grade 9-12
- 1
Define a 401(k) retirement account in your own words. Include who usually offers it and why workers use it.
Think about the connection between a job, a paycheck, and retirement savings.
A 401(k) is a retirement savings account usually offered by an employer. Workers use it to save and invest money for retirement, often with tax advantages and sometimes with employer matching contributions. - 2
Define an IRA in your own words. Explain what the letters IRA stand for and how it is different from a 401(k).
IRA stands for Individual Retirement Account. It is different from a 401(k) because an individual usually opens it on their own through a bank, brokerage, or investment company rather than getting it through an employer. - 3
Maya earns $48,000 per year and contributes 6% of her salary to her 401(k). How much does she contribute in one year?
Convert 6% to a decimal before multiplying.
Maya contributes $2,880 in one year because 6% of $48,000 is 0.06 × 48,000 = 2,880. - 4
An employer matches 50% of an employee's 401(k) contributions up to 6% of salary. Leo earns $60,000 and contributes 6% of his salary. How much does Leo contribute, how much does the employer contribute, and what is the total yearly contribution?
Find Leo's contribution first, then calculate half of that amount for the match.
Leo contributes $3,600 because 6% of $60,000 is $3,600. The employer contributes $1,800 because 50% of $3,600 is $1,800. The total yearly contribution is $5,400. - 5
Nia earns $42,000 per year. Her company matches 100% of her 401(k) contributions up to 4% of salary. If Nia contributes only 2% of her salary, how much employer matching money does she receive? How much matching money would she receive if she contributed 4%?
A 100% match means the employer adds the same amount as the employee, up to the limit.
If Nia contributes 2%, she contributes $840 and receives $840 in employer matching money. If she contributes 4%, she contributes $1,680 and receives $1,680 in employer matching money because the company matches up to 4% of salary. - 6
Explain the difference between a traditional retirement account and a Roth retirement account in terms of when taxes are usually paid.
In a traditional retirement account, contributions may reduce taxable income now, and taxes are usually paid when money is withdrawn in retirement. In a Roth retirement account, contributions are made with money that has already been taxed, and qualified withdrawals in retirement are usually tax-free. - 7
A student sees this statement: Contributions to a traditional 401(k) can lower taxable income for the current year. Explain what this means using a simple example.
Taxable income is the amount of income used to calculate income tax.
This means that money put into a traditional 401(k) may not be counted as taxable income for that year. For example, if a worker earns $50,000 and contributes $3,000 to a traditional 401(k), the worker may be taxed as if they earned $47,000, depending on tax rules. - 8
The chart shows three savers who invest the same amount each month but start at different ages. Explain why starting earlier can make such a large difference by retirement.
Starting earlier can make a large difference because the money has more time to earn returns, and those returns can also earn returns. This process is called compound growth, and it becomes more powerful over long periods of time. - 9
Jordan invests $100 per month in an IRA. Write an expression for how much Jordan contributes in 1 year and calculate the total. Then calculate how much Jordan contributes in 10 years, not including investment growth.
There are 12 months in one year.
In 1 year, Jordan contributes 12 × $100 = $1,200. In 10 years, Jordan contributes 10 × $1,200 = $12,000, not including investment growth. - 10
A retirement account balance is $5,000. It earns a 6% return for one year, and no new money is added. What is the new balance at the end of the year?
The account earns $300 because 6% of $5,000 is 0.06 × 5,000 = $300. The new balance is $5,300. - 11
Read the scenario: Sam leaves a job after one year. Sam contributed $2,000 to a 401(k), and the employer contributed $1,000. The employer contributions vest after three years. Explain what money Sam definitely keeps and what money Sam might lose.
Vesting means gaining full ownership of employer contributions over time.
Sam definitely keeps the $2,000 that Sam contributed because employee contributions belong to the employee. Sam might lose the $1,000 employer contribution because it is not vested until after three years. - 12
Choose the better explanation: A person should treat a retirement account like a regular checking account, or a person should usually leave retirement money invested for the long term. Explain your choice and include one possible consequence of early withdrawal.
A person should usually leave retirement money invested for the long term because retirement accounts are designed for future needs and compound growth. One possible consequence of early withdrawal is paying taxes, penalties, or both, depending on the account and situation.