401(k) vs. IRAs

When saving for retirement, most investors think of two options immediately: 401(k) plans and IRAs. But not everyone is familiar with the differences between them. Don’t let your fear of the unknown hold you back.

If you’re planning for retirement and wondering whether a 401(k) or an IRA might make the most sense for your specific situation, you’ve come to the right place. Keep reading this post to learn about what 401(k) plans and IRAs are, the differences between them, and what kinds of investors might benefit from each (or even both). Here’s a quick overview of IRAs vs. 401(k) plans: 

Source: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits

What Is a 401(k)?

A 401(k) is one of the most common types of retirement accounts. 

Many employers include these kinds of retirement accounts in their benefits packages. Those who participate have a certain percentage of each paycheck automatically routed to their retirement account, and in many instances, employers offer a matching program. 

For example, an employee might put 5 percent of their salary in their 401(k), and their employer might match half of that amount.

In 2020, those who have a 401(k) are able to contribute up to $19,500 of pretax income to their account (in 2019, the maximum was $19,000). People over the age of 50, however, are able to make “catch-up contributions” by adding an additional $6,500 to their 401(k) (i.e., if you’re over 50, you can put up to $26,000 in your 401(k) retirement account in 2020).

On the plus side, 401(k) plans offer a tax-deferred way to save for retirement—once again, often with an employer bolstering your contributions. 

You don’t have to pay taxes on your money until you cash out—which you can do, without a penalty, once you are 59½. (If you withdraw money before then, you may get hit by a 10 percent penalty in addition to your tax obligations.) 

You may also be able to borrow against your 401(k) funds during a financial pinch. But you’ll have to repay this money, plus interest, to avoid penalties.

But, like everything else, 401(k) plans have downsides. Generally speaking, you won’t have granular control over which securities you invest in. You may be limited to the investment options your plan sponsor provides. Depending on who’s administering your plan, you may also be on the hook for fees.

For many investors—and particularly those who work for companies that offer generous 401(k) matching programs—the pros seem to outweigh the cons for this retirement vehicle.

Now that you have more information, let’s look at IRAs and the different types to help you assess IRAs vs. 401(k) plans.

What Is an IRA?

An individual retirement account, or IRA, is another tax-deferred account that offers potential tax benefits. 

IRAs, like the name suggests, are self-funded; employers don’t get involved with these kinds of accounts. In 2020, you can put up to $6,000 in an IRA—and up to $7,000 if you’re at least 50 years old. (In 2019, these maximum contributions were the same, $6,000 and $7,000, respectively.)

With these lower-capped contributions, if you're behind on saving for retirement and need to catch up, an IRA might not be the best option.

Whereas you don’t have granular control over your 401(k) investments, you can pick and choose the exact composition of your IRA accounts, managing them the same way you would any other investment account. 

Once you put money into a traditional  IRA, however, you can’t withdraw it until you’re 59½. Otherwise, you may get hit with a 10 percent penalty.

What is a traditional IRA?

A traditional IRA is funded with pretax dollars—just like a 401(k). Taxes are due, though, once you take qualified distributions after you turn 59½. Some investors may opt to convert their traditional IRA into a Roth IRA.

What is a Roth IRA?

A Roth IRA is just like a traditional IRA, with one major difference: Roth IRAs are funded with post-tax dollars. This means you pay taxes before making your contributions to your retirement account, but you don’t have to pay taxes when you receive qualified distributions after you turn 59½.

Of course, not having to pay taxes on your gains is generally seen as a positive thing. But because you’re putting post-tax dollars into a Roth IRA, you may be able to invest less money  compared to a traditional IRA.

Investors can either open a Roth IRA or convert a traditional IRA into a Roth IRA. However, Roth IRAs can’t be converted back to traditional IRAs.

IRA vs. 401(k): Which Option Sounds Best to You?

When it comes to planning for retirement, every investor has different preferences. Some might be content with maximizing their employer’s contributions to their 401(k) plan, while others might not even have an option to contribute to a 401(k). Other investors might prefer either of the popular IRAs, while still others might have both a 401(k) and an IRA.

If your objective is to maximize your contributions, you may consider using both. Please consult an investment advisor or financial planner and a tax professional to discuss and understand what additional retirement accounts are available to you.  

Figuring out which investment vehicles make the most sense for your retirement plan can be tricky. If you need some extra help, you may want to speak with a financial advisor who can work with you to build a plan that is specific to your needs. 

To learn more about 401(k) plans and IRAs—as well as the other important factors you need to consider as you plan for retirement—download our new e-book, The Retirement Planning Guide for People Who Don’t Want to Work Forever.

Disclosure:

• The decision to open a retirement account and/or they type(s) can be a difficult one. There a numerous options and each option may present benefits and restrictions. 401(k)s, Traditional IRAs and Roth IRAs are not the only retirement account options available to investors. Many unique factors that are specific to the individual needs and goals of an investor should be considered prior to selecting a retirement account. Other options exist that may be better suited to your individual needs. 401(k)s and employer match options are not offered by all employers. Please consult your employer regarding their respective retirement plan options and benefits. Please consult a tax professional before implementing a retirement account 
• There is no guarantee that a Roth IRA or 401(k) will be a suitable option for your retirement needs or that any of the referenced benefits will be achieved or sustained. Accordingly, your personal experience with any of the accounts mentioned in this post may be better or worse than what has been indicated here. or any account referenced herein.

• Information presented is general in nature and should not be viewed as a comprehensive analysis of the topics discussed. It is intended to serve as a tool containing general information that should assist you in the development of subsequent discussions. Content does not involve the rendering of personalized investment advice nor is it intended to supplement professional individualized advice.   
• Hiring a qualified advisor and/or financial planner does not guarantee investment success, and does not ensure that a client or prospective client will experience a higher level of performance or results. No guaranty or warranty is made that any direct or implied results or projections being represented here will be met or sustained.
• The need for a financial advisor or financial planner and/or the type of services required are specific to the uniqueness of each individual’s circumstances. There is no guarantee or warrantee that the services offered by EP Wealth Advisors, LLC will satisfy your specific financial services requirements. Services offered by other advisors may align more to your specific needs.  
• All investment strategies have the potential for profit or loss. Different types of investments and investment strategies involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client's portfolio. The risk of loss can never be eliminated even if working with a professional. 
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