Unless you happen to be independently wealthy, planning for your retirement should be a concern for you. The possibility of retiring on Social Security benefits alone is not very realistic. Most working age Americans are at somewhat familiar with 401ks and IRAs, as they are very common retirement tools. However, many clients want to know which is better, IRA or 401k? As with most things, there are both pros and cons associated with IRAs and 401ks. Deciding which retirement tool is the best for you depends on your specific needs for your retirement.
Understanding the 401k
A 401k is one kind of retirement plan, created pursuant to Section 401(k) of the Internal Revenue Code, which was enacted in 1978. That statute sanctioned a new type of contribution plan that allows employees to make pre-tax contributions, which are automatically deducted from the employee’s paycheck each pay period.
The Individual Retirement Account
An Individual Retirement Account or “IRA,“ is a savings account that allows an individual to put money aside for future retirement, while earning tax-free income. It is essentially a savings account with considerable tax breaks, making it an easy way to save for your retirement. IRAs are typically established by either the individual or the employer.
What are the advantages of a 401k
The government has created limitations for both IRAs and 401ks. These limitations include the amount pre-tax funds can be invested every year. One of the best advantages of a 401k is that the maximum contribution limit is higher than for an IRA. In 2015, the annual limit for 401ks is $18,000, whereas for an IRA, the maximum is only $5,500.
Another benefit of a 401k is that employees are able to borrow money a 401k account without penalty. The only requirement is that you pay the money back. An IRA cannot be borrowed against. Another unique benefit is that you can withdraw funds from your 401k before you reach age 59 ½, if the purpose is to pay medical bills or because of disability.
What are the advantages of an IRA?
There are also benefits associated with an IRA. IRAs provide a variety of investment choices, which are otherwise limited with 401k plans. Also, with an IRA, you have the option of modifying your investment choices rather easily. On the other hand, 401k plans only allow modifications at certain times.
Which type of retirement plan should I choose?
Believe it or not, it is not a bad idea to include both a 401k and an IRA in your retirement plan. Retirement plans are very flexible and can be customized to fit your particular needs and objectives for your retirement. In order to appreciate the benefits of both types of plans, it is very common for both 401ks and IRAs to be included in an overall retirement plan.
If you have questions regarding IRAs or 401ks, or any other retirement planning needs, please contact the Schomer Law Group either online or by calling us at (310) 337-7696.