Retirement is not as clear-cut and simple as it was in the past. Instead of relying on retirement from your work and Social Security benefits, retirees must plan for their golden years many years before they occur. This is typically done with two retirement “workhorses”: the IRA and the 401k.
Both the 401k and the IRA have contribution limits, which when reached will not allow you to add any more. At this point you must seek other methods of saving for retirement. However, contributing to your 401k and your IRA should be your first plan of action.
In many companies you will have the option for your employer to match your contributions. Although each employer is different, they will typically match your contributions dollar for dollar up to a certain amount. However, if you are in a situation where you may be able to save more money than is able to be matched by your employer, you may want to consider investing in an IRA.
However, the fact is there is not simple answer or perfect retirement plan. Each holds specific advantages and disadvantages that must be considered carefully when planning for retirement. One of the main differences of the two types of accounts are the way that taxes are paid. The IRA tax is paid up front, which means the money that accrues is kept tax free, including when you begin withdrawing from the account. You can choose a Roth IRA, which allows you to pay tax now so you don’t need to worry about paying taxes in the future since inflation will occur.
A 401k on the other hand, is almost the complete opposite. You begin putting money in this account tax free, however when you withdraw your funds you pay tax on both the money you withdraw as well as the earnings in the account. You can choose a Roth 401k plan but you will need to change your current plan, which could cost you a lot of money in fees to convert it. However there are other advantages and disadvantages as well, which include:
- 401k’s require holders to begin taking withdraws when they turn 70 and a half, however IRAs do not require withdraws, which allows the account holder to pass on the savings to their beneficiaries.
- If you plan to use the funds that are saved yourself you must try to estimate if the tax rates will be higher when you start the fund or when you plan to begin your withdraws. This will help you determine which type of account you should establish.
The fact is that the business of 401k’s and IRAs can be extremely difficult to understand. However, hiring a financial advisor can help you determine what is best for your specific financial situation.