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401k or IRA: Which is a better retirement savings plan?

Planning for retirement (or even just thinking about starting a retirement plan). Do you choose a 401k plan or an individual retirement account (IRA)? These plans may be similar but choosing one or the other could affect how you save for your retirement. Each may have tax implications, employer involvement, or investment options regarding your money. How do you decide which is best for you?


Each retirement account has unique benefits and impacts that you have to choose between. Your choice may not be 401k vs IRA. You may find there are advantages to having both. The real advantage is educating yourself on how they will allow you to invest now and retire in the future.


Ultimately, your retirement plan needs to build towards your retirement saving goals. So let's look at each investment option so you can make the best retirement decisions for you. It's a good idea to be as informed as possible when making decisions that could affect your future, so here's a breakdown and some helpful hints.


What is a 401k?


Contributing directly to a 401(k) plan from your earnings before taxes is one of the benefits of working for an employer.


For the purposes of simple math, if you earn $2,000 per paycheck and you decide to contribute 5% of your earnings to your 401k. Your employer would deposit $100 from your paycheck directly into the retirement account your employer created for you. This amount would be closer to $73 if you deducted your income tax from your earnings before depositing the 5% employee contribution.


Who manages your 401k


Much like your employer-provided health insurance plan, you may not have a choice over what company manages your company's retirement account. Investing dollars in your account is up to you, and you have choices about how much you contribute. You have additional options, too. Stay tuned.


Employer contributions to your 401k


In addition to the pre-tax benefit, one of the most common perks of a traditional 401k is that employers may offer a matching contribution up to a certain percentage. For example, if your employer offers to match your contributions up to 6%. Then it's in your best interest to also contribute at least 6% so that you get all that money your employer is offering towards your retirement. Otherwise, you're saying "no" to extra savings in your retirement account.


401k employee contribution limits


The Internal Revenue Service does limit your 401k contribution in a single calendar year. Although the amount may change from year to year. The IRS publishes limits on its website.



What is an IRA?


An IRA, or individual retirement account, is all about the individual — no employer involvement. Anyone can contribute to their own IRA until they reach the age of 70½ years of age.


Similarities to a 401k account


An IRA account and a 401k account do have similar features. The funds you deposit into your IRA account can be tax-free. When you file your taxes, you can include your IRA contribution if you've already paid income tax on your earnings. Tax deductions will be available for these contributions. It is important to know that the IRS does set limitations on tax-free IRA contributions. This is based on individual income limits, including specific limits for those who file joint tax returns.


Differences in a 401k account


One of the biggest distinctions between a 401k and an IRA is that there is no employer contribution. Self-employed individuals or employees without access to a 401k retirement plan might find IRAs appealing.


Individual retirement accounts may also be beneficial if you wish to contribute more than what your 401k allows. You might also open an IRA if you want to roll over your funds from an existing 401k, or a 401k from a previous employer. As the IRA owner, you choose what company manages your retirement savings account.


Can you have both?


Both types of accounts differ primarily in that employers offer 401ks, while individuals open IRAs. Since your employee contribution to either is entirely voluntary, you may choose either or both retirement accounts.


Having both a 401k and an IRA provides the greatest opportunity to make the investment choice that best suits you. If you have questions about which option is best for you, speak to a financial advisor.


401ks that include employer contributions are often the best place to start contributing enough to receive the maximum match. If you're eligible, you can also open an IRA and contribute the annual maximum.


If you have a 401k from a previous employer, you can roll it over into your new 401k with your current employer or into an IRA. Just like that, you could have both types of retirement accounts.


How to choose between a 401k vs IRA


Oh, choices. Why do they have to be so hard to make? Well, this one doesn't have to be. There are a few key things to consider when comparing an IRA and a 401k: contribution, cost, and flexibility.


Contribution


A 401k has a significantly higher maximum contribution level than an IRA. Plus, having an employer contribution towards your retirement is money that you should not pass up. Some people talk about employer contributions as "free money," but it's part of your overall earning package if it's available. Take advantage of it.


While you can choose if you want your investments to go towards a specific stock, bond, or mutual fund with either type of retirement account, only an IRA allows you to choose your investment company, too. This may make it easier to manage all your retirement accounts if you have more than just your employer-offered 401k.


Cost


When choosing between a 401k and an IRA (or even both), you might want to consider whether it is more advantageous to contribute taxes now or when you begin your required minimum distribution upon retirement. This may not be immediately obvious, and the advice of a financial advisor may help guide your decision.


Flexibility


The decision to invest in a 401k vs an IRA is different for everybody, and really it depends on your individual set of circumstances. What your decision boils down to is whether your employer matches contributions:


If your employer offers a 401k with a company match: You can put money in your 401k to get the maximum match. That match may offer a 100% return on your money, depending on the 401k. If your employer doesn't offer a company match: You might want to skip the 4010) and start with an IRA. With an IRA, you'll have access to a large selection of investments, and you'll avoid the fees associated with some 401ks. After contributing up to the IRA limit, you always have the option to pay into a 401k for the pre-tax benefit it so graciously offers.


When it comes to retirement, there's no such thing as saving too much. It's in your best interest to use all the savings and investment tools available to you. Start early and begin building your retirement even if you have yet to decide when you want to retire, or what your retirement plans may be.




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