When you’re planning for retirement, which plan do you choose: a 401(k) or IRA? These plans may seem similar, but choosing one or the other could affect how you live in retirement. Both plans offer tax-deferred retirement savings, but they each feature a few key differences. 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 401(k)?
A 401(k) is an employer-sponsored retirement plan where your employer may offer matching contributions up to a certain percentage. When you contribute to your 401(k), your contribution is pre-taxed, meaning you won’t pay taxes on it until you withdraw during retirement. In 2015, employees can contribute up to $18,000 of pre-tax income into a 401(k), and if you’re over 50, you can contribute an extra $6,000. If your employer offers to match as much as 6 percent of your salary, you should contribute at least 6 percent — otherwise you’re saying “no” to extra savings in your pocket.
What is an IRA?
An IRA, or individual retirement account, is unique from a 401(k) in that anyone can contribute as long as they are younger than 70 and 1/2 years of age. An IRA promises tax-deferred growth, just like the 401(k), but the IRA is all about the individual. You’ll be the only one making contributions, as there is no employer match. In 2015, you’re allowed to contribute up to $5,500 if you’re under age 50, and up to $6,500 after age 50.
Can you have both?
The main difference between the two types of accounts is that employers offer 401(k)s, while IRA accounts are opened by individuals. So in theory, yes you could have both.
Having both a 401(k) and an IRA provides the greatest opportunity to save money and remain flexible with it. Start by contributing enough to your 401(k) to receive the maximum match from your company. If you’re eligible, open an IRA and contribute the annual maximum.
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 there’s no way you’ll regret it.
How to choose
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 401(k): contribution, cost, and flexibility.
A 401(k) has a significantly higher maximum contribution level than an IRA. Here's a great example of this difference, courtesy of investors.com:
Say you leave your job and you're no longer eligible to contribute to that employer's 401(k), then you need to seriously consider the carrying cost associated with either option.
The cost of a 401(k) can vary greatly (ranging from 0.5% to 2%) and typically an IRA is less expensive. However, it's important to do your research.
Both plans offer a lot in terms of flexibility but there are limited funds available to you with a 401(k). An IRA however, has limitless options.
The decision to invest in a 401(k) vs and IRA is different for everybody, and really it depends on your individual set of circumstances. What you decision boils down to may be the following:
If your employer offers a 401(k) with a company match: You can put money in your 401(k) to get the maximum match. That match may offer a 100% return on your money, depending on the 401(k). (Ka-ching!?)
If your employer doesn’t offer a company match: You might want to skip the 401(k) 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 401(k)s. After contributing up to the IRA limit, you always have the option to pay into a 401(k) for the pre-tax benefit it so graciously offers.