When it comes to choosing between a retirement account sponsored by your employer, and one that is a self-directing type of savings account like an IRA, the perfect answer would be to choose both. This would ensure that you have all of the retirement savings that you will need to live comfortably. But unfortunately, maxing out both of these retirement options is not an option.
401k vs IRA – The Short Answer
In reality, it’s best to prioritize your savings and focus more on one type of retirement plan or the other. The one that is best for you can depend on several factors.
When To Contribute To A 401k
If your employer offers you a 401k plan with a company match, you will want to go with this option. It would be best to fund your 401k up until you get the maximum amount of matching dollars from your employer. After that, you can consider getting an IRA. If you happen to max out your IRA for the year, you can go back to your 401k and then resume your contributions with that plan.
When To Contribute To An IRA
If your employer doesn’t offer a company match for their 401k, you will want to start off with an IRA instead. After you have contributed to the limit on your IRA, then you can start focusing on funding your 401k and take advantage of the pre-tax benefits it provides.
Taking A Closer Look At 401k vs IRA – Which Is Better?
Before you decide whether you should go with a 401k plan or an IRA, it is important that you understand more about both types of plans first.
What Is A 401k?
A 401k is a retirement savings plan that is sponsored by your employer. This retirement plan allows you to save and invest in a portion of your paycheck before any taxes are taken out. The taxes aren’t paid until the money has been withdrawn from the account.
What Is An IRA?
An IRA is an account that you set up at a financial institution such as a bank. It allows you to save for retirement with tax-free growth or on a tax-deferred basis.
There are three main types of IRAs:
Traditional IRAs are preferred by workers who are closer to retirement age and those in a higher tax bracket than they expect to be once they retire. The contributions are deductible with a traditional IRA, but if your retirement savings are covered by your 401k as well, that deduction could be either reduced or completely eliminated based on your income.
You will need to refer to current IRA contribution limits to find out if your deduction will be affected due to contributing to a traditional IRAs.
About Roth IRAs
A Roth IRA is a good choice for those who are not eligible to deduct traditional IRA contributions. It is also a good choice for those who are currently in the lower tax bracket or those who anticipate being there once they retire.
Your Roth IRA eligibility will not be affected if you also have a 401k. However, it could be affected by your current income. Therefore, you should also check out the Roth IRA contribution limits to find out more about your eligibility for this type of account.
A rollover IRA is the third type of retirement savings plan. When you have a traditional IRA, it is intended for the money to be rolled over from another qualified retirement plan. Rollovers an include moving assets from a 401k or other type of employer-sponsored plan, into your IRA.
What Are The Contribution Limits For A 401k vs IRA?
Both an IRA and a 401k will have contribution limits that you can’t go over. In 2018, the contribution limits for a 401k was $18,500 for those who were under the age of 50. And $24,500 for those who were over the age of 50.
For a Traditional or ROTH IRA, there was a $5,500 combined IRA limit and $6,500 for all who were age 50 or above.
If you are able to save enough money to reach the contribution limits or max out both your 401k and your IRA for the year, then you have managed to do something that even the most frugal individuals can do.
It is nearly impossible for anyone to max out both their 401k and IRA, that’s why it’s recommended that you only try to focus on one retirement account at a time. Work on maxing out one account and then if you achieve that goal for the year, start working on contributing as much as you can to the other.
What You Should Do If Your Employer Offers A Match For Your 401k
If your employer offers a 401k match, then your first step should be to contribute enough funds to your account so that you may earn a full match.
You will want to check your employee benefits handbook to get all the facts about how they contribute these funds. Your employer may match any portion of the money that you contribute to the company’s 401k, or the terms may be different. Get the facts first before you proceed.
One of the biggest benefits you can have if you are saving for your retirement with a 401k is for your employer to match your contributions. This means that your employer matches the money in your account up to a certain amount.
In most cases, an employer will match a portion of the amount that you save, up to the first 6% of your gross earnings.
Keep in mind that even if your 401k plan has limited investment options or higher than normal fees, you should still set aside enough money each time you get paid to receive the full match from your employer. This will guarantee that you get a return on your investment dollars.
The next thing that you should do is put as much money as you can afford to into your IRA. There are two different types of IRAs, traditional and a Roth. You can either choose to get a tax break now while you are saving, or get the tax break later on once you begin to withdraw funds for retirement.
Once you have maxed out your IRA, you should then revisit your 401k. Even if you have gotten the full contribution match from your employer, and even if you have limited investment choices, you can still benefit from your 401k.
All the retirement savings that you add to your 401k will help lower your taxable income for the year. And there is also the added benefit of the tax-deferred growth on your investment gains.
What You Should Do If Your Employer Doesn’t Offer A Match For Your 401k
If your employer doesn’t offer a match for your 401k retirement plan, there are still a few things that you can do to ensure that you get the maximum benefit out of your retirement savings.
Try Contributing To An IRA First
Unfortunately, not all companies will match a portion of your retirement account contribution. And if that’s the case for you, it is best to choose an IRA to contribute to first.
One of the main benefits of having an IRA is that it provides you with access to a broad variety of investments. This allows you to have more control over your retirement savings.
You can even comparison shop for the most affordable index mutual funds and ETFs, instead of being limited to the offerings in your workplace retirement account.
You also have the advantage of avoiding all administrative fees that are common with 401k plans. IRAs are an obvious choice if you want to save as much as possible for retirement, but money is currently tight.
Once you manage to max out your IRA benefits, you should start to contribute to your 401k. The tax deferral benefits alone are a good enough reason to add funds to a 401k even after you have contributed all you can to your IRA.
401k vs IRA – Which Is The Best Option For You?
Several factors can help determine whether contributing to an IRA or a 401k is the best option for you. While it's impossible to max out on both, you can contribute the maximum amount to either an IRA or a 401k, and later contribute to the other for the remainder of the year.
When choosing between a 401k and IRA, it is important to choose the one that you will benefit from the most during your retirement years. If your employer offers a full match for your contributions with a 401k, you should definitely consider maxing out that retirement plan first before you start on an IRA.
If your employer doesn’t match your contributions, however, it would be in your best interest to start working on your IRA plan first.