When it comes to tax-advantaged retirement savings accounts, people have many options. The most popular retirement savings accounts are 401(k)s and IRAs. Both accounts are similar in many ways, but they also come with notable differences. It’s important to view them through the lens of retirement planning.
401(k)s, IRAs, and the Retirement Years
As you move closer to retirement, you move into the “protection” stage. After accumulating wealth over the years, it’s time to start preserving it for retirement. If you currently have your money in a 401(k), you should consider rolling it over into an IRA, with a strategic amount of it allocated in an annuity.
- As you approach retirement, your interests turn more income-related
- People tend to spend less in retirement than in their working years
- By rolling your 401(k) funds into an IRA, with a suitable amount in an annuity, you’ll protect yourself from losses from market declines
- In other words, staying in the 401(k) means more market risk
- With the right annuity (and possibly with an income rider), you’ll receive a guaranteed income stream with the chance to earn interest on your money
- IRAs don’t have ongoing, costly management and service fees like 401(k)s
- If the money is left alone, those costs will continue eating into your 401(k) earnings
Of course, people’s current situation, future needs, and future goals will vary. This approach is worth considering in lieu of your retirement needs, but ultimately the choice of retirement strategy lies with you. Here are some other retirement basics which may help you make well-informed decisions.
The 401(k) is a tax-advantaged, employer-sponsored retirement plan. Like the IRA, it comes in traditional and Roth options. Most investors go the traditional account route. Making contributions to a 401(k) will reduce your tax burden on the front end. Moreover, your funds grow on a tax-deferred basis.
401(k) plans aren’t just for those in a “traditional” employment capacity. Most plan-holders are, but you can also get specialized 401(k) plans if you’re a small business owner. Keep in mind that these plan options tend to be complex. If you’re interested in them, consult with an accountant or a financial advisor for professional guidance.
Unlike the 401(k), most IRA options aren’t sponsored by employers. There are some IRA options which are, though. IRA stands for “Individual Retirement Arrangement.” Nonetheless, it’s also known in the financial community as an “Individual Retirement Account.” Many workers without a 401(k) option go with this retirement savings account.
Like the 401(k), the IRA is a tax-advantaged retirement savings account. There are many options for IRAs, including traditional and Roth. However, Roth IRAs may come with limitations depending on certain conditions. Deductible IRAs allow your funds to grow tax-deferred. If you’re self-employed or a business owner, there are more specialized IRA options – consult with a financial advisor or an accountant.
401(k) vs. IRA Benefits
There are different advantages to both retirement savings accounts. When comparing different options, it helps to think of each account as a “tax wrapper.” In other words, a retirement account is simply a classification of how you allocate your assets for tax purposes. Comparing a traditional 401(k) and a traditional IRA, here’s a breakdown:
401(k) benefits include:
- High contribution limit of $18,000 (2016 tax year)
- For people aged 50 and over, the catch-up limit is $6,000 (2016 tax year)
- Permits employer matching of up to 6%
- Contributions are income tax deductible
- Tax-deferred fund growth
- Emergency withdrawals available (withdrawers must meet strict conditions)
IRA benefits include:
- High contribution limit of $5,500 (2016 tax year for many IRAs)
- Catch-up contribution up to $6,500 for those aged 50 and over (2016 tax year)
- Low setup cost and easy to create
- Contributions are tax deductible (depending on your income bracket)
- Can open yourself or through a bank, online broker, or other vendor
- Can invest in stocks, bonds, mutual funds, annuities, and other assets
- More flexibility in asset allocation and adjustments
- Permits emergency withdrawals without penalty (if withdrawn amount replaced within 60 days)
401(k) vs. IRA Cons
Of course no retirement savings account comes without some disadvantages. Here are some downsides for 401(k)s and IRAs:
401(k) disadvantages include:
- Limited investment options compared to IRAs
- Lower-quality investing options compared to IRAS
- Costly service, maintenance, management fees
- Providers give reports meeting only legally required standards
- Not as much flexibility for asset allocation as IRAs
- Not likely to have same fund managers over your time horizon
- Performance reports typically aren’t investor-friendly
- May have huge tax implications when taking distributions
- Needs precise self-monitoring to determine performance
- Even if early withdrawal permitted, may have to pay 10% penalty
- Doesn’t give options for letting you draw guaranteed income
- Early withdrawal penalty if money taken out before age 59.5
- Contributions can limit or eliminate potential IRA contributions
- Potential waiting periods of 6 months to 1 year
- Required minimum distributions at age 70.5
IRA disadvantages include:
- Many IRAs have lower contribution limits than 401(k)s
- Early withdrawal penalty before age 59.5
- Harder to play “catch up” in retirement savings (for many IRAs)
- Deductible contributions can be reduced or eliminated by 401(k) contributions
- May have no deductible Roth IRA contributions (depends on household income)
- Required minimum distributions at age 70.5
If you’re planning out your retirement, conferring with an Independent, Safe Money Advisor may help. Call us today at 877.GROW.SAFE (877.476.9723) to request a consultation, address your questions, or for immediate assistance!