How does a 401(k) compare to an IRA?featured

Hey, there. Getting old? Or you’re actually in your twenties, or thirties but you feel old? That’s a question best answered in a mental health blog post. Nonetheless, right now would be a good time to start thinking about financial security in the future and retirement. We all need a source of income or money we can rely on in our old age, and we can start early by making a well-informed investment in an IRA or a 401k account, or both. There are many routes to investing and saving, but it depends on you to decide what best fits your way of living, mindset and employment, so that you may get the most value.

What is a 401(k)?

A 401(k) is a retirement plan that is sponsored by an employer. Any contributions to it are taken directly from your paycheck and are tax-deferred until withdrawal. This means that your money will be able to comfortably grow, with no taxes paid until you choose to withdraw. There is a limit to how much you can contribute to a 401(k). The annual contribution caps down to 23,000 in 2024, and those who are 50 or above can invest an additional 7500.  Another advantage to this account is that companies match your investments to a certain amount, usually varying from 3 to 6 %. Through a 401(k), an employer also provides an investment portfolio that includes a range of investment options. The higher the risk, the greater the growth potential. In most cases, mutual funds, which include stocks, bonds or target date funds are the typical go-to.

What is an IRA?

An IRA stands for individual Retirement Account, and is available to anyone that earns an income, without having to go through an employer. At times, even a spouse who doesn’t earn an income can contribute to the savings. Similar to a 401(k), this account also has a tax advantage as you don’t need to pay taxes until the funds are withdrawn. The annual limit is 7000, and 8000 for people 50 and above. This retirement account can be opened at many different financial institutions, like banks and brokers. This account has a great range of investing options, like stocks, bonds, mutual funds and ETFs. After the age of 59, you’ll be able to withdraw your funds without penalty.

Which one is better? A 401(k)or an IRA?

In both a 401(k) and an IRA, taxes are deferred so, you don’t have to pay taxes until you withdraw your funds. In the best case scenario, it is encouraged to have both of these, so you could take advantage of the benefits provided by both, but as most people wouldn’t be able to afford to contribute to both, it makes sense to find the account best suited to your lifestyle.

A 401(k) is more secure from creditors, in the case of bankruptcy, or a lawsuit. Additionally, it has a higher contribution limit compared to a traditional IRA, and the funds are automatically taken out of your paycheck, so you don’t have to concern your time with this, and focus it on investing. The employer matches your contributions to the account which is basically free money, and a great advantage. Although, there are penalties for using the funds in a 401(k) account, you have the option of taking out a loan. On the flip side, an IRA doesn’t provide this, but it does give an array of investing options that a 401(k) doesn’t include. With an IRA, anyone can open this account, even if you don’t have an employer. As there is a Roth version for both a 401(k) and an IRA, it is easier to set up a Roth with an IRA.

In conclusion, it seems that a 401(k) is by far more profitable and will be able to give you more retirement savings, but as said before, it is best to have both a 401(k) and IRA to get the most flexibility in how much taxes you’ll have to pay in the future.