When it comes to saving for retirement, which type of account is best for you to open? The answer depends on your particular set of circumstances. For most, an IRA (Individual Retirement Account) or a company sponsored 401(k) is the easiest and best route for you to take. So which one should you choose? Here is a rundown of the differences between the types of accounts which should help you decide which one is right for your needs.
401(k)s are notorious when it comes to having only a few options that you can invest in. When you look through your 401(k), you’ll notice that you only have a handful of different stocks and funds that you can invest your savings in. However, when it comes to IRAs, these constraints no longer apply. This is especially true when you open your IRA with a larger investment firm. This is because many of these firms offer many of their own mutual funds that you can invest in. IRAs also allow you to invest in physical precious metals, real estate, private lending, private placements, energy oil & gas, bitcoin, as well as other alternative investments.
401(k)s tend to be more expensive than IRAs when it comes to investing. This expense is known as an expense ratio and is a numerical value that is reflective of the fee that is assessed for your investment activity. In a 401(k), this fee can be as high as 6.3% per $1,000 invested as compared to 0.01% per $1,000 invested in an IRA. And this isn’t the only fee that is assessed to 401(k) account holders. There are various other account maintenance fees associated with 401(k)s that can eat into your profits.
401(k)s, as well as traditional IRAs, allow you to invest pre-tax dollars and grow your investment more quickly. However, this can mean a considerable tax burden when you start taking distributions from your account at retirement. A Roth IRA eliminates this uncertainty by requiring you to pay your taxes up front, before investing your money, which allows you to take your distributions tax-free. Why does this distinction matter? It is important because the tax rate may be considerably higher at the time of your retirement, meaning that you will have to pay a much larger share of your earnings to the government when you retire than you planned.
In most cases, withdrawing money from your retirement account, regardless of which one you have, will earn you a hefty bill, both in terms of a large tax bill as well as a 10% penalty for your early withdrawal. However, with an IRA, there are certain circumstances that allow you to make a withdrawal from your account without penalty. These include taking an up to $10,000 withdrawal for the purchase of a home or to fund higher education for yourself or a family member. With a Roth IRA, you can take a distribution for any reason without having to pay taxes or penalties on the amount.
In an IRA, you are the only one making contributions to your account. However, with a 401(k), many employers make annual matching contributions as an incentive, allowing you to grow your account balance more quickly.
And, these are just some of the differences between IRAs and 401(k)s. Before opening your account, take the time to research both options and choose the right one for your needs.