Are mutual funds considered retirement accounts?

Unlike a 401(k) or Individual Retirement Account (IRA), mutual funds are not classified as retirement accounts. Employers generally do not sponsor them like a 401(k), and the Internal Revenue Service (IRS) does not offer the tax benefits on mutual fund accounts that it does for 401(k) plans or IRAs. Earnings from qualified retirement plans are not subject to taxation until a person withdraws money from the account.

With that said, investing directly in mutual funds can be an effective way to save for retirement. In fact, many 401(k) plans offer the option to have some or all of the money invested put into mutual funds.

Mutual Funds Explained

A mutual fund is a pool of hundreds or even thousands of stocks, bonds and other asset classes. While it is subjected to the same market whims as individual investments, its inherent diversification makes it safer and less volatile. Investing in individual stocks poses extra risk because the investor's money is tied up in a single company. Failure of that company often means financial ruin for those invested heavily in it. By contrast, the failure of a single company has a far less dire effect on investors who are only exposed to it as part of a mutual fund, since their money is spread across hundreds of companies.

How Mutual Funds Fit Into Retirement Plans

Retirement plans, such as 401(k)s, allow savers some degree of control over how their money is invested. Investors get to choose between mutual funds, index funds and other types of investments.

Mutual funds are a popular choice for 401(k) holders who have autonomy over how their retirement savings are invested. The main drawback for using a 401(k) to invest in mutual funds is most retirement plans have a limited number of funds from which to choose, often 20 or fewer.

While not classified as retirement accounts, mutual funds can offer an effective and relatively safe way to accumulate long-term wealth for retirement.