As retirement draws nearer, there are a lot of crucial decisions that must be made. One of those is setting up a retirement account. When setting up a retirement account, you would likely be faced with a dilemma: should you go with a traditional Individual Retirement Account (IRA) or a traditional 401(k) account?
While there are other forms of retirement accounts, these two are the most used. There are a lot of different rules that govern these accounts which seem similar on the surface, giving them certain distinctions. Consider some of them.
A 401(k) account holder is allowed to fund his account tax deferred. Both the initial investments and the gains realized within the plan remain untaxed by the IRS. Taxation begins to occur when the account holder has reached the retirement age and has begun making withdrawals from the account. These withdrawals will be taxed at the retiree’s current income tax rate.
An IRA is practically funded by after-tax money. This is because, unlike the 401(k), it is not funded before income tax is deducted from your earning; since it is not provided by your employer. As a result, the IRS levies no taxes on your withdrawals during retirement. It also levies no taxes on your investment gains, much like the 401(k).
Limits To Contribution
When it comes to savings ability, consideration must be given to limits to yearly contribution imposed by the government. As of 2018, the 401(k) allows a yearly contribution limit of $18,500 for those aged under 50. While those above 50 are allowed to increase this amount by $6,000 to make for a total of $24,000. However, the IRA accounts had an imposed yearly limit of $5,500 for under 50, and $6,500 for 50 and over.
Although a 401(k) account allows for more contributions, it offers limited diversity. With an IRA account, you have great control over how you wish to invest your funds, thereby controlling your possible earnings and fees. Simply put, an IRA allows you diversify your portfolio. You can choose to invest in a precious metal such as gold, or you can decide to diversify your stock market portfolio. It’s all left for you to decide.
This is hardly the case with a traditional 401(k) account with very much limited investment options. This plan is an employer-sponsored plan which limits your options to those provided by your employer.
When opening a work retirement account, you stand the chance of getting instant returns on your investment from your employer. For that to happen, you would have to contribute enough money to your account. But this is only possible with a 401(k) account. Basically, your employer specifies an instant return of between 50% and 100% depending on the size of your yearly contribution. Note that whether this offer exists and the parameters guiding it all depend on your employer.
However, this incredible offer cannot be found on any retirement account besides the 401(k). Because an IRA is more of a personal account than a work (employer) account, you bear the full responsibility of the account.
Although this is never a good idea, certain desperate times might force you into considering borrowing from your ‘future’ self to prevent something drastic. In this case, you will find a 401(k) account handy.
Depending on your workplace plan, you might be able to take a loan from your 401(k). Repayment will then be done with interest. However, there are certain very specific guidelines and terms which you must keep to for this to be a success.
An IRA account, on the other hand, makes no provision for loan withdrawals. This means any money removed from an IRA is considered a deduction rather than a loan to be repaid, and can come with as much as a 10% penalty charge.
Which should you go with?
In the end, both the IRA and 401(k) accounts avail you a chance to save for your future by investing in your future self. This makes them very important accounts; so you must be well aware of account specifics before making a final choice. It is not also impossible to diversify between both plans.
For the most part, a consideration of the differences between a 401(k) and an IRA account involves a look at the contribution limit and portfolio diversification. While the IRA gives you more investment independence, the 401(k) allows you save more.
The decision of which to go with would also depend on the specifics of the 401(k) plan on offer from your employee. Be sure to take the time to analyze both plans before settling for any.