401(k) vs. IRA: Which is Better for Retirement?

Written By Jeff Hindenach
Last updated March 3, 2020

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November 13, 2016

Simple. Thrifty. Living.

Thinking of putting money aside for retirement? That’s a sign that you’re prudent with your personal finances; it’s never too early to begin planning for your future. Traditional IRAs and 401(k) savings accounts are the most common vehicles for retirement investing, so as you prepare for your older years, you’ll need to figure out which of these will work better for you. Below is an overview that will provide you with some of the pros and cons:

The main difference between these two types of accounts is that 401(k) plans are offered by employers, while IRAs, or Individual Retirement Accounts, are set up by individuals through their bank or mutual fund company. Solo 401(k) plans, for self-employed sole proprietors, are also available and function similarly to those offered through employers.

Both IRAs and 401(k) plans can be structured to use either pre-tax contributions (which you will only pay income tax on when you withdraw the money in the future) or post-tax income (which will be tax-free for you in the future.) The plans which you contribute to with post-tax income are called “Roth” plans.

If your employer offers to match your contributions to a 401(k).  Some employers will contribute as much as 6 percent of your salary (providing you are also contributing the same amount), and this employer contribution is a definite plus, being essentially free money.  Not only that, your contributions can be deducted from your paycheck before tax is calculated, so they lower your tax liability for now. Later, when you are retired and begin drawing from the plan, you will pay income tax on the funds, but most likely at that point you’ll be in a lower tax bracket.

If you feel comfortable with the way the 401(k) funds are invested. You will most likely have some options regarding the way in which your employer invests these funds, and it’s important to review these options. Many companies invest 401(k) funds heavily in their own stock, and if there should be a sudden drop in your employer’s net worth, your hard-earned retirement savings can evaporate overnight.

If you don’t have an accumulated sum to start with
. Most 401(k) plans simply allow you to begin making small contributions with each paycheck, and there is no minimum investment. IRAs, on the other hand, generally expect you to start with a sufficient sum of money to buy a CD or shares of a mutual fund.

If you’re not prepared to be actively engaged in investment planning. Investopedia warns that “the quality of the investment options offered in your plan may be well below average, particularly if you are a participant in a small retirement plan.” They suggest you conduct a due diligence evaluation of how your company’s 401(k) is being invested before you decide to contribute funds.

If you’re concerned about fees. Often the decreased flexibility of a 401(k) will mean that the fees involved are higher than you could find if you shopped around on your own. If you care about finding the lowest investment fees, you may wish to put as much as you can into an IRA.

If you need flexibility with the timing of your contributions. You can contribute to an IRA for any given calendar year all the way up to the tax filing deadline (around April 15) of the following year. This leeway can be very helpful for some business people whose income is irregular.

If you’re leaving a job that had a 401(k). You are permitted to roll over your 401(k) funds into an IRA, and this is usually a good idea if you’re not moving directly into a new job that offers a 401(k).

If your heirs might want to withdraw funds a little at a time
. The beneficiaries of an IRA are usually permitted to withdraw funds slowly over their lifetime, allowing greater growth for the investments.

If you think you might need to borrow some of your retirement funds ahead of time, for medical or other short-term expenses.  While you are permitted to borrow out of your 401(k) — as long as you pay yourself back — you do not have this type of emergency access to the funds in an IRA.

If you want to contribute more than the annual ceiling amount
. IRAs impose a much lower annual limit on your contributions than 401(k) plans. Currently if you are under 49 years old, you are only permitted to invest $5,500 per year into an IRA. If you’re over 49, you’re allowed to contribute $6,500. The 2013 limit on 401(k) plans is $17,500 per year.

Yes. Most of the top online investing sites offer IRAs but very few have 401(k) options. Here’s a breakdown of the best sites and what deals they offer.

OptionsHouse: This site offers IRA options and will give you 100 commission-free trades and $125 in transfer fees if you start an IRA with them. Check out their site here.

TD Ameritrade: They also offer an IRA and will give you $600 when you open a new account with them.

Cryptocurrency: If you want to invest in cryptocurrency, you need a company that specifically invests in cryptocurrency. BitIRA is a cryptocurrency app that can help you set up a crypto IRA.

Each of these methods of investing for retirement offers some distinct pros and cons, and many people actually decide to maintain both at once. Doing just a bit of homework will enable you to choose the right vehicle for ensuring that you have a comfortable future.

About the Author

Jeff Hindenach

Jeff Hindenach is the co-founder of Simple. Thrifty. Living. He graduated from Bowling Green State University with a Bachelor's Degree in Journalism. He has a long history of financial journalism, with a background writing for newspapers such as the San Jose Mercury News and San Francisco Examiner, as well as writing on personal finance for The Huffington Post, New York Times, Business Insider, CNBC, Newsday and The Street. He believes in giving readers the tools they need to get out of debt.

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