The age-old comparison- IRA vs. 401(k)!
Everyone says that you need to start investing for your retirement right away, but what account is your best option?
If you aren’t familiar with the different types of investing accounts or terminology, it can be really confusing to know where to start and what’s best for your retirement.
In this article, we’ll discuss the different types of investment accounts so you can get a quick skinny of what may work for you.
If you are looking for an easy stress-free way to roll over your 401k we highly recommend Capitalize.
Table of Contents
IRA VS. 401k- The Quick Run Down
You have likely heard of them before, but the most common types of retirement accounts are IRAs and 401(k)s.
They mainly have some differences when it comes to income tax, their contribution limit, and more- but first, you need to know how you get an IRA or a 401(k) account.
You set up IRAs on your own, but a 401(k) is offered by your employer.
If you want to plan out your taxes to prepare your retirement savings, some IRA accounts are tax-deductible while 401(k)s always are.
Key Differences- IRA VS. 401(k)
Ins and Outs of an IRA
Individual Retirement Accounts (IRAs) are typically set up by you rather than by your company. You can start as early as you’d like to save for retirement, which is always what we suggest.
There are a few different types of IRAs, but the most typical investment choices are Traditional or Roth IRAs.
Traditional IRA VS. Roth IRA
The main difference between a Traditional IRA and a Roth IRA is to do with the tax, and when it is applied.
With a Traditional IRA, your contributions are tax-deductible, although there are limits for the deductibility.
A Traditional IRA is best for you if you want to get a tax break immediately, as your contributions may be deductible (which means your taxable income will be lower).
A Roth IRA is best for you if you are looking for tax-free growth on your investments, and want to withdraw cash in your retirement without paying any tax.
Check for Employer Contributions
Employees may have a sponsored plan with SEP and Simple IRAs that they can offer you, and it’s worth checking out the contribution limits (a very important aspect!).
SEP And Simple IRAs
For those who want to know a bit more about IRA options than the Traditional and Roth options, here’s a little information on these for you.
SEP IRAs
SEP IRAs are only for your employers to contribute to. The contribution amounts are much higher – your employer can contribute up to 25% of your gross annual salary (the contributions must not go over $57,000 however).
Simple IRAs
The contributions work a little bit differently with Simple IRAs. Your employer can match up to 3% of your annual contribution, or instead set up a 2% contribution.
The contribution limits are also a bit lower – currently, they are $13,500, with an additional contribution allowance for people over 50 years old of $3,000.
Limits On IRA Contributions
The contribution limits for both Traditional IRA’s and Roth IRA’s are $6,000 per tax year (as of 20/21). If you are aged 51 years old or over, you are awarded an extra $1,000 as a catch-up contribution. Nice!
If you need to withdraw cash from your retirement savings early, you may have a penalty-free withdrawal depending on the circumstances, like for health reasons or educational commitments.
Be sure to research if any of your investment options for retirement have free withdrawals or any other perks- it may be a big draw for wherever you decide to open your retirement account!
Pros And Cons Of Your IRA
Pros
- Better options as there are more investment selections for you to choose from
- Roth IRA: when you withdraw the money during retirement, it is tax-free (if qualified)
- Easy to set up, many options to open IRAsm and you can open them at any time
- Not very complex
Cons
- Hands-on, need to invest your money yourself and get involved with investments
Ins and Outs of a 401(K)
A 401(k) is a retirement savings account that is tax-deferred, typically composed of different investments like mutual funds. Your employer can open a 401(k) for you.
The mutual funds that are selected will be chosen by your employer based on certain risk tolerances so that you can have as risky investments – or not – as you want.
Employer Contributions
A 401(k) will benefit you most if your employer will match your contribution, great! You’ll want to do that first since you can double your investments without much effort on your part.
The best way to think of it is as free money!
The contributions that you make to your 401(k) are pre-tax, which means that your contributions reduce the tax that you pay on your income for the year.
Currently, for the tax year, you can contribute up to $19,500 in both a Traditional or Roth 401(k) with people aged 50 or older being able to do a catch-up contribution.
No 401(k) Price Match
If your employer doesn’t match your 401(k) contributions, it may be better to set up an IRA account first.
Employers tend to match the employees’ contributions up to a certain percentage, and this is important to check because you want to make sure that you are going to be following the rules.
To get the employer match, you will need to reach the minimum amount required. Make sure that you check through your documentation to see what you need to do to get the match.
Limits On 401(k) Contributions
When you’re age 50 or older, your contribution limit will be $26,000 in 2021.
If you’re under 50, you’ll be able to contribute up to $19,500 into your retirement account.
Alsa, check for income limits on 401(k) plans- if you make above a certain amount at your job, you may not be eligible for tax reduction benefits.
Pros And Cons Of Your 401(k)
Pros
- Tax-deductible, and they lower your taxable income in the years that the contributions are put in
- Contribution limits are higher
- Employers will usually match what you invest up to a certain percentage
- Offers better security from creditors and lawsuits, which is extremely helpful in protecting your wealth and retirement funds
Cons
- Taxed as ordinary income at retirement (unless it is a Roth 401(k))
- Limited amount of investments that you can choose from
- Little control over the plan and costs associated with it
Capitalize
Have you heard about Capitalize?
If you have 401(k)’s with previous employers and aren’t sure what to do with them, Capitalize will help you to sort them out.
Sometimes we move jobs, and our 401(k)’s will sit there, forgotten about, accruing fees!
With Capitalize, you can move your money over to an IRA and avoid all the unwanted fees.
Investment FAQs
Should I Set Up An IRA Or A 401(k)?
When wondering whether to go with an IRA or a 401(k), you need to look at your current situation and what would be best for it.
In an ideal world, you will have both, and be able to max them both out each tax year, for maximum benefit. If you aren’t at a level where you can do this, don’t worry, as this can happen over time as your income grows.
One of the key things to consider is whether or not your company offers an employee contribution match. That sweetens your retirement pot, that you haven’t had to do anything for.
Have a look through your employer’s 401(k) plan or speak to them, to check the level of contributions that they do. It is in your best interest to contribute the maximum amount that you’re able to to get the employer match.
The next step after doing this ideally is to invest in an IRA. You will need to choose between a Traditional IRA or a Roth IRA, depending on the type of tax breaks that you are looking for.
After you then max out your IRA, it’s a good idea to go back to your 401(k) to take advantage of the tax deduction benefits.
But, you could find yourself in a position where your employer doesn’t offer a 401(k) match, which will mean a change of plan.
If that is the case, then you will probably want to first contribute to an IRA. After maxing out your IRA, you can then contribute to a 401(k) to take advantage of the tax benefits.
So to answer the question of whether you should set up an IRA or a 401(k), it depends on your personal circumstances, and in particular if your company offers matches.
You want to make sure that you take advantage of any extra money that you can get, as well as any tax breaks.
For Taxes, Are IRAs And 401(k)s The Same?
In terms of taxes, IRAs and 401(k)’s are not treated the same. You may think that because they are both retirement accounts, that the tax would be the same – but it’s not.
With a Roth IRA, the withdrawals in retirement are tax-free, although the contributions are not tax-deductible.
With a Traditional IRA, there is a tax deduction that is offered.
And with a 401(k), you can reduce your taxable income by doing contributions in the pre-tax phase.
Can I Lose Money In An IRA Or 401(k)?
The short answer is yes – you can lose your money just like with other investment opportunities.
It’s really important to think about whether or not you can afford to lose money in an IRA or 401(k), as this is your hard-earned income.
It’s being invested in a similar way to other accounts, which means it will never be 100% risk-free. It’s another reason why regardless of what you pick, you need to be hands-on with your account.
Investment Opportunities
There are lots of great investment and financial companies out there to help you get a hand on your finances, such as:
Robinhood
Robinhood was the first individual stock investment platform to offer commission-free trades, which exploded their popularity.
On the Robinhood app, you can trade stocks, funds, and also more unusual investment opportunities such as investing in cryptocurrency.
M1 Finance
M1 Finance is another popular investing platform, that offers no commissions on your investments.
When you sign up for M1 Finance you will choose your portfolio, which is made up of stocks and exchange-traded funds.
Betterment
Betterment is the leading robo-advisor site, a popular online investing platform. We love that you can invest depending on what kind of goals you have (you can select them on the site).
They have a really low management fee of 0.25% (it’s important to check the fees) which means, for example, if you had a $1,000 account, you would be paying $0.25 per year to them.
Mint
Mint is another extremely popular finance company – you’ve probably heard of them before.
Mint specializes in helping you manage your money, through budgeting tools such as a spending analysis, bill pay reminders, credit monitoring, and more.
Chime
Chime isn’t an investment company, but you need to make sure that you are managing your money well when you are trying to invest.
Chime is a financial tech company that believes banking should be free and easy, which they do by partnering with banks to design financial products for you.
Cryptocurrency
Cryptocurrency is a digital currency, which is fairly new and very popular. You may have heard of some crypto like Bitcoin.
As mentioned, Robinhood is an app on which you can invest in cryptocurrency if you so wish. It’s worth noting that not all investing platforms have this as an option.
Stocks, Bonds, Etc.
When it comes to investing, you must know the things that you are investing in.
Stocks are viewed as a higher-risk investment because you are buying a part of a company, although you can spread this risk with things like index funds.
Bonds are viewed as lower risk, as they are usually loans to things like governments, who are more likely to pay you back!
Our Key Takeaways
When it comes to personal finance, things are always personal. This means that you need to look at the information that’s available to you and make it work for your circumstances.
Whether you go for an IRA or a 401(k), or both, will be up to you. Make sure you check what your employer does, such as if they offer a company match as you need to get your free money!
It’s always a good time to start investing, whether for retirement or to increase your income. Check all your investment options and join the investor bandwagon!
