How to Choose Between an IRA and a 401(k)

No matter where you are in your career, it is never too early to plan for retirement. If you’ve been avoiding setting up a retirement savings plan because you don’t know where to start, you’re not alone. The two main types of retirement savings plans are a 401(k) and an IRA—but how do you know which one is best for you? Determining which kind of retirement savings plan is right for you will depend on which option fits your specific lifestyle. Here, we will look at a few of the key differences between the two and when it’s advisable to invest in an IRA or a 401(k).

What is a 401(k)?

A 401(k) is a retirement savings plan through your employer. Contributions are normally deducted straight from your paycheck into your 401(k). The money put into your 401(k) will grow over time as it is invested on your behalf into mutual funds, stocks, and bonds. You can contribute up to $19,000 a year to a 401(k) and there are no income restrictions. Money in your 401(k) cannot be taken out until you reach age 59 ½ without a 10% penalty, but after you are 70 ½ you must take minimum distributions. Your contributions are tax-deductible, but you will pay income taxes on money you withdraw from your 401(k).

There are a few ways to tell if a 401(k) is a good retirement investment for you:

– Your employer offers a 401(k) and will match your contributions, essentially giving you free money.

– Automatic paycheck deductions will make you less tempted to spend the money. It is gone before you ever have it in your hands.

– You have reached your IRA’s maximum annual contribution. You could use a 401(k) to maximize your savings.

– You want to take advantage of the tax benefits of a 401(k). Because the contributions to your 401(k) are taken out of your paycheck before taxes, you could reduce your taxable income and therefore fall into a lower tax bracket. This could allow you to receive higher income tax returns.

What is an IRA?

An IRA, or individual retirement account, is the other most popular retirement savings plan. An IRA is not through your employer and will therefore stay with you no matter how much your lifestyle changes. You can invest up to $6,000 per year until you are 50, at which point you can invest $7,000 per year. Like a 401(k), you cannot withdraw money before age 59 ½ without paying a 10% penalty and you must make minimum withdrawals after you are 70 ½.

Your IRA contributions may be tax deductible depending on your financial situation, but any withdrawals will be taxed as income. However, this is different if you have a Roth IRA. With a Roth IRA, you pay taxes up front on your contributions, but you do not have to pay taxes when you withdraw later. There are no income limits with a Roth IRA and because you pay taxes up front, you can withdraw your funds at any time without paying a penalty. There is also no mandatory minimum distribution requirement at a certain age, so you do not have to touch your contributions until you are ready.

A traditional IRA or Roth IRA may be right for you if:

– Your employer doesn’t offer a 401(k) match or any other retirement plans. IRAs allow you to save and invest on your own terms, even if you don’t have access to a retirement savings plan through your employer.

-You change jobs a lot or don’t plan to stay with your current employer. An IRA stays with you no matter where you go or who you work for.

-You are in a lower tax bracket. Especially if you are young, you can invest what you can in a Roth IRA now while paying the lowest possible taxes.

-You want to control how your money is invested. Whereas with a 401(k) you are paying someone to make investments for you, IRAs give you control over what kind of investments your money goes to.

The Takeaway

At the end of the day, the most important thing is that you pick a plan and start saving consistently. When you are looking at your options, don’t be afraid to compare different plans and services provided. There are so many variables that go into saving for retirement and it can be hard not to become stagnant with worry about the what-ifs. Focus on what you can control: making steady contributions to a retirement savings account that fits your lifestyle.

What to do with Your Old 401(k) When Changing Jobs

401k

When you are looking forward to a new job, your retirement savings plan is typically not the first thing on your mind. However, for many of us, an employer-sponsored 401(k) is one the biggest and most financially beneficial perks of a job. Your 401(k) is your future. It is a huge factor in your ability to retire when you are ready and live comfortably in your golden years. That being said, what happens to your old 401(k) when you leave your current job? The best decision will often depend on your specific financial circumstances. Here, we look at the four options you have for your 401(k) when you are starting a new job.

1. Leave it

Of all the options available to you, leaving your 401(k) where it is with your previous employer is the easiest option. The money in your account will continue to grow tax-deferred and be available to you upon retirement. If the plan comes with low fees and good investment options, you may want to stick with it. There are some cons to keeping your 401(k) with your previous employer. Depending on the employer, you may not be able to make additional contributions, take a plan loan, or make a partial withdrawal once you leave. Some employers will charge higher fees if you aren’t an active employee. There is also the risk that you could miss important updates about your plan, or forget about the account entirely. This option will highly depend on your individual circumstances and the details of your former employer’s plan.

2. Roll it into your new plan

While this may not be an option with all plans and every place of employment, this option will allow your retirement savings to continue growing, tax-deferred. You will be allowed to make contributions to the account, typically after a mandatory probation period ends. If your new employer has a better plan (lower fees, better investment options, etc.), it might be worthwhile to take your money with you. There are two ways you can roll your old 401(k) into your new one:

  • Direct rollover: The administrator of your old plan transfers the money directly into your new 401(k) account.
  • Indirect rollover: The administrator of your old plan transfers the money directly to you. Then you must manually apply the money to your new account. This option is typically for people who are in need of a short-term loan. Your employer will withhold 20% for taxes in case you decide to keep the money outright. If you add the money to your account in full within 60 days, the 20% will be returned to you when you file your tax returns.

3. Roll it into an IRA

Instead of rolling over your savings into another 401(k), you could put those funds into an individual retirement account (IRA). Because this account does not have to be connected to an employer, it is a great option for those leaving their job to go back to school, become stay-at-home parents, start their own business, or for those who do not have access to another 401(k). The money can be sent directly or indirectly, only this time you will not have to pay taxes like you would with a 401(k) or a Roth IRA. With an IRA, your money will be able to grow tax-deferred and you will have access to a wider variety of investment options than with a 401(k). An IRA also does not require you to pay fees if you withdraw your money for college, to buy your first home, or to pay off medical debt.

4. Cash Out Your 401(k)

When it comes to deciding whether or not to cash out your 401(k), it really depends on you and your specific circumstances. Most financial planners and asset protection attorneys will advise against it; taxes and penalties will cause you to lose a big chunk of the money you and your employer have invested. However, you know your financial situation best. You may need a big lump of cash to go back to school, as an emergency fund when one parent decides to stay home with the kids, or to start your own business. If you are considering cashing out your 401(k), you MUST make sure you understand what it will cost you.

When you cash out your 401(k), your employer will typically withhold 20% of your balance to pay off the IRS. You will also have to pay state taxes and, if you are under 59 ½, a 10% early withdrawal fee. It is also important to understand that by cashing out this money early, you will be missing out on the money your account could be making in the years between now and retirement. A 401(k) with $50,000.00 when you are 35 will turn into $216,000 by the time you retire at 65. If you were to cash out this 401(k) now, after taxes, fees, and penalties, you would receive approximately $35,000.

Veitengruber Law has experience providing long-term planning guidance at any stage in your career. Protecting your assets and preparing for retirement will look different for every client. We offer personalized strategies to help you make informed decisions about your retirement goals.