The Ultimate Showdown: 401(k) vs. IRA

401k vs ira

401(k) vs. IRA: Where Should You Stash Your Cash

Barrels and holes in the dessert may now always be the most practical option.  Unless you’re laundering $80 million of drug money.  And if you are, then the show-down between the 401(k) vs IRA may not be so interesting.  With the traditional pension becoming all but extinct among employers, the burden of retirement savings has quickly shifted off the shoulders of organizations onto individual employees. Setting aside funds for retirement is an inevitable task these days, but determining which savings vehicle is most appropriate for your unique circumstances and total income need can be daunting. According to U.S. News and World Report, the two most common retirement savings vehicles for individuals include the 401(K) plan and the IRA savings account. To help you make the best decision for your own retirement needs, let’s examine how each option works.

401(K) Basics

A 401(K) plan is defined as an employer-sponsored retirement vehicle, meaning it is established by and made available through a business. Each 401(K) plan offered by an employer differs slightly from the next, but there are certain aspects of the plan that work similarly across the board. First, contributions from employees into a 401(K) plan are voluntary, and are made through paycheck deferrals. Employees have the opportunity to elect either a specific dollar amount or percentage of earnings to be siphoned off and placed into the 401(K) account, and the balance that accrues is invested per the allocation selected by the employee. It is important to note that investment options within a 401(K) plan are limited in number and, oftentimes, scope.

Contributions made to a 401(K) are tax-deferred, meaning no tax is assessed on interest or investment gains earned throughout the year; however, funds cannot be directly withdrawn from the plan without penalty until the employee reaches age 59 ½, fully retires, or changes jobs. Additionally, contributions may be made on a pre-tax or post-tax basis, depending on how the plan is established through the sponsoring company.

Individuals who have access to a 401(K) can set aside up to $18,000 per year, with an additional $6,000 allowed for individuals over age 50. Employees may also benefit from a 401(K) matching program where the employer contributes an amount on behalf of the employee, up to certain limits. Loans against 401(K) balances may also be available for certain financial needs. Overall, the 401(K) savings plan offers a simple way to shore up retirement savings – and earn “free” money through matching contributions – for employees who have the option available.

IRA Savings Accounts

As an alternative or supplement to 401(K) plans, individuals have the opportunity to establish an individual retirement account, more commonly known as an IRA. The IRS developed the IRA option specifically for individuals without access to an employer-sponsored plan, but anyone with an earned income has an opportunity create and contribute to an IRA. This type of account differs from a 401(K) in that contributions are made directly from a checking or savings account, not paycheck deferrals, and the account owner has full control over where funds are invested. An IRA can be established through a variety of financial institutions and is in no way associated with an employer or business.

IRA savings accounts operate in the same manner as 401(K) plan in that investment gains are tax-deferred until money is withdrawn, and penalties apply if funds are taken out prior to age 59 ½; loans, however, are not permitted from IRA savings accounts. IRA contributions can be made as either pre-tax (traditional) or post-tax (ROTH), although individuals who earn more than a certain amount each year are not eligible to contribute to the latter. For the 2016 tax year, individuals can contribute up to $5,500 into an IRA, with those over age 50 afforded an additional $1,000 contribution.

Which is Best for You?

Employer-sponsored plans are one of the few savings vehicles that offer employees a way to set aside funds for the long-term through paycheck deferrals. Given that 401(K) contributions are often matched by employers, contributing to the plan is typically a smart choice. Individuals who do not have access to a 401(K) plan through work, or who feel obligated to save beyond the 401(K) limits should consider utilizing an IRA for retirement goals. IRA savings accounts offer a wider variety of investment selections, and ultimately control over accumulated savings. However, the contribution limit for IRAs is relatively low in comparison to 401(K) plans, and income restrictions may apply to post-tax accounts.

Leave a Reply