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401(k) vs. IRA – Which is Better?

Posted by : Premraj | Posted on : Saturday, June 30, 2018


Ahhh, retirement. Does any word sound better right about now? Whether you’re going to be the type to sleep in and then fish all day or one who perhaps works part time, retirement is most certainly the universal goal. The harsh truth, though, is that not everyone plans ahead well enough to enjoy his or her retirement, so it’s never too early to consider what’s your best way to invest in your future. When it comes to a 401(k) and an IRA, which should you choose? Let’s explore that below.

What’s the Difference?

In order to know which is better for you, you need to fully understand what they are and how they differ. And if you’d prefer to cut out the middleman and handle your investments (at least mainly) yourself, you might also considering employing the services of a robo advisor. Whatever you end up opting for, it’s important to enhance your savings account regularly, so that you can hit those Golden Years stress-free.

Tell Me About the 401(k)

A 401(k) (along with the 403(b) and 457) is an employee-sponsored retirement plan. So if your employer does not offer one of these, your decision is obviously made for you.

A big benefit of the 401(k) is that many employers will match a certain percentage of your salary contribution. As this US News Money article notes by way of an example, “Saving 6 percent of your pay in a 401(k) plan and earning a 3 percent 401(k) match means you are tucking away an amount equal to 9 percent of your salary each pay period for retirement. For a worker earning $50,000 per year, this means an annual 401(k) contribution of $3,000, plus another $1,500 in employer contributions.” In essence, if you’re not doing this, you’re turning down free money.

The other huge benefit of the 401(k) is that your contributions are all pre-tax money, so you won’t be taxed on it during the year that you earned it. You will, however, pay taxes on it once you withdraw it for your retirement. Each year, the amount you are allowed to contribute in pre-tax money to your 401(k) will change, but a simple Google search will help you assess that.

What’s an IRA?

The major distinction between an IRA and a 401(k) is that anyone can contribute to a traditional IRA. You don’t have to be employed by a company to do so, as long as you are under the age of 70.5. As with the 401(k), an IRA offers tax-deferred growth on investments. Depending on the IRA, it very well could also offer tax-deductible contributions as well.

A Roth IRA, however, offers different tax advantages from the traditional IRA. Instead of paying tax on the income when you withdraw it, you pay it as you make the contributions. Not everyone qualifies for a Roth IRA, though. In order to qualify, you must have an adjusted gross income that is less than $116,000. If you file jointly as a married couple, then this number lands at $183,000.

Another similarity between the 401(k) and the IRA is that they both have limits for their annual contributions, and the limit is the same for both the traditional and Roth IRAs. For Roth IRAs, the 2018 contribution limit begins to decrease when your income hits $120,000 or $189,000 for those filing jointly. Again, however, this changes from year to year, so a simple Internet search will help you find where you are at with this limit.

Can I Have Both?

A common myth is that you can and/or should have only one or the other, but you don’t have to choose between a 401(k) and an IRA. Keep in mind, though, that you if you do have a 401(k) through your employer, you lose your tax deduction benefits of the IRA once your income goes over $73,000.

Break It Down For Me

The bottom line is that, if you’re saving for retirement at all, that’s a good thing. If your employer offers a 401(k) with matching contributions, however, it’s almost silly not to take advantage of that. Remember that part about the free money. In fact, if your employer matches all contributions (some do this!), that’s the same as a 100 percent return on investment.

However, other than the matching, there aren’t a huge number of advantages or disadvantages between the two investment accounts. The main factors to consider are as follows:

— The maximum contribution level with a 401(k) is much higher than with an IRA (about 10 times higher with employee contributions), and both options offer a “catch-up contribution limit” for those aged 50 and up

— When you leave your job, you are no longer allowed to contribute to that employer’s 401(k), so you’ll either want to roll this money into your next company’s 401(k) or into an IRA.

— An IRA can cost less, but you need to check your 401(k) documents to be sure. As this article by The Motley Fool notes, “The costs associated with a 401k vary significantly: I’ve seen them range from nothing to 2% annually.”

— IRA accounts often have little to no annual fees

–Your 401(k) options are usually limited, while IRA investment options are virtually limitless

To put this into a bite-sized summary, turning down a 401(k) with matching contributions is turning down free money, so just go for it. Don’t panic, though, if you don’t have this option, as the various kinds of IRAs have their own advantages.

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