Contributing 401k vs. IRA: What’s the Better Choice?

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Investing for your retirement is something you should think about very early on in your career. By planning ahead, you can ensure the financial resources and proper savings to retire comfortably. As you look into retirement resources, two of the most common options are a contributing 401k and an IRA. By breaking down the two options, you can choose an ideal account provider and start off your retirement savings the right way.

Annual Limits

One of the more basic comparisons to make between a contributing 401k and an IRA are the annual limits that you have for each account. If you are under 50 years of age, there are strict limits to the amount that you can invest in each type of account. For example, in a 401k account, you can invest up to $17,500 annually. In an IRA account, you can invest $5,500.

These amounts are significantly different, but you typically have more flexibility and options when choosing an IRA account. For example, IRA accounts may be separate from your employer and consist of flexible deposit options. The annual limits are also separate for each type of retirement account. This means that you have the option of opening both a 401k account and an IRA for a total annual investment of $23,000.

Employer Contributions

Setting up a 401k plan requires you to have an employer that offers these plans. One of the biggest differences between the 401k and a traditional IRA is the ability to earn employer contributions. Every time you invest money into a 401k, an employer may match those amounts. This essentially equals an instant return on your investment and is an ideal way to easily build up money in your account. When placing money into an IRA, the money is not matched, but you may have more options in terms of stocks, bonds, and mutual investments for the account.

Couple Discusses IRA account options

Losing or Changing Jobs

One of the biggest disadvantages of signing up for a 401k account is your inability to invest in it after changing employers. Once you leave an employer, the contributions end and you can no longer personally deposit into the account. The account is still yours, but in order to contribute to it, the entirety of it must be rolled over into an IRA. This process requires paperwork and possible fees, and it can result in delays for money that you want to add to the account. Once you obtain a new job, you will need to start a new 401k and start building up a separate account again.

By having your own IRA account, you have the ability to keep that account no matter where your career takes you. Deposits into the account are flexible as long as you do not exceed the legal account limits.

Annual Fees

A lot of IRA accounts are free to set up and manage. The only types of fees that you will commonly encounter are commissions for stock purchases or trades. Many types of IRA account providers can also provide commission-free trades for a set amount of time or during a specified promotional period. By comparing these different providers, you can find the best options without spending a fortune on fees.

A 401k account can come with several fees that are not associated with IRA accounts. For example, there may be an annual administrative fee applied to your account to help cover the cost of managing employee accounts. Additional fees may come with money transfers and employee contributions. Before making a final decision on the type of retirement account that you seek, it’s a good idea to break down the fees and determine which account results in greater savings for your situation.

401k binder

Taxes & Accounts

When contributing to any type of retirement account, it’s important to understand the tax implications that these accounts may have. For a majority of IRA and 401k accounts, the investments that you make are considered pre-taxed income. For example, if you put in $50 a week, that money will not be taxed or count toward your taxable earned income. Your money will not be taxed until you retire and cash out of the accounts.

One of the only exceptions to this rule is a special type of IRA account known as a Roth IRA. When you invest into a Roth IRA, your income is taxed upfront. This means that when you retire, you can cash out of the accounts without any tax implications and enjoy the full account balance that is available to you. The annual account deposit limits of $5,500 also apply to this account.

As you decide on the type of retirement account you want to open, it’s important to acquire as much knowledge as possible. Understanding your career, account options, and tax information can make it easier to make a final decision on your retirement.

Get your retirement plan started early. Once you decide on an IRA or 401k, you can compare plans and options from some of the top banks.

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