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IRA vs. 401(k)

Comparing two popular retirement account types.

By Cornerstone Wealth Management

When you think about retirement accounts, it is likely that at least one of these two account types come to mind: the IRA and the 401(k). Each are common and relatively easy ways to save for retirement. Each have unique and common features and benefits. What follows is a summary of features, merits, and demerits of each account type.

What IRAs and 401(k)s have in common.

  • Taxes are deferred. One significant advantage is that funds held in these accounts have the potential to grow and compound year after year tax deferred.1 When money is eventually withdraw from either plan, it will be taxed as ordinary income.
  • IRAs and 401(k)s can reduce ordinary income taxes. It varies depending on whether the account is traditional or Roth in nature. Contributions to a traditional IRA may be tax deductible while contributions to a 401(k) lower your taxable income. When money is eventually withdraw from either plan, it will be taxed as ordinary income. When you have a Roth IRA or Roth 401(k), contributions are not tax deductible, but can potentially be withdrawn from the account without taxation.1
  • Generally, the I.R.S. penalizes withdrawals from these accounts before age 59½. Distributions from traditional IRAs and 401(k)s prior to age 59½ usually trigger a 10% federal tax penalty, on top of income tax on the withdrawn amount. Roth IRAs and Roth 401(k)s allow you to withdraw a sum equivalent to your account contributions at any time without taxes or penalties, but early distributions of the account earnings are taxable and may also be hit with the 10% early withdrawal penalty.1
  • You must make annual withdrawals from 401(k)s and traditional IRAs after age 70½. This is called a Required Minimum Distribution (RMD). And while withdrawals from a Roth IRA are not required during the owner’s lifetime, only after his or her death. Roth 401(k)s do require annual withdrawals after age 70½.2 At this point, you may be starting to get confused on the nuances. If you have questions, we welcome you call.

How IRAs and 401(k)s differ.

  • Annual contribution limits for IRAs and 401(k)s differ greatly. As an employee non-business owner, you may direct up to $18,500 into a 401(k) in 2018; $24,500, if you are 50 or older. In contrast, the maximum 2018 IRA contribution is $5,500; $6,500, if you are 50 or older.1 The additional $6,500 contribution is called a “catch-up.”
  • Your employer may match your 401(k) contributions. This is free money coming your way. If your employer offers matching, amount of match differs by employer, is usually partial, but certainly nothing to disregard – it might be a portion of the dollars you contribute up to 6% of your annual salary, for example. Do these employer contributions count toward your personal yearly 401(k) contribution limit? No, they do not. Retirement planning tip: Consider contributing at least enough to qualify for the full match if your company offers one.1
  • An IRA permits a wide variety of investments, in contrast to a 401(k). The typical 401(k) might offer only about 20 investment options, and you have no control over what investments funds are chosen. With an IRA, you can have access to hundreds of investment options.1,3
  • You can contribute to a 401(k) no matter how much you earn. Your income may limit your eligibility to contribute to a Roth IRA; at certain income levels, you may be prohibited from contributing the full amount, or any amount.1
  • If you leave your job, you cannot take your 401(k) with you. It stays in the hands of the retirement plan administrator that your employer has selected. The money remains invested, but you may have less control over it than you once did. You do have choices: you can withdraw the money from the old 401(k), which will likely result in a tax penalty; you can leave it where it is; you can possibly transfer it to a 401(k) at your new job; or, you can transfer it into an IRA.4,5
  • You cannot control 401(k) fees. Some 401(k)s have high annual account and administrative fees that effectively eat into their annual investment returns. How costa are established is beyond your control. The annual fees on your IRA may not be as expensive.1

All this said, contributing to an IRA or a 401(k) is a prudent idea. In fact, many pre-retirees contribute to both 401(k)s and IRAs in the same tax year. Today, investing in these account types appear to be essential in achieving retirement savings and retirement income goals.

If you or someone you know would like to get coaching on the most appropriate approach to saving money for retirement, or would like assistance with the jargon below, we welcome your call.

Note: Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax. The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.

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This material was prepared by MarketingPro, Inc. and does not necessarily represent the views of the presenting party nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.

1 – nerdwallet.com/article/ira-vs-401k-retirement-accounts [4/30/18]
2 – irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions [5/30/18]
3 – tinyurl.com/y77cjtfz [10/31/17]
4 – finance.zacks.com/tax-penalty-moving-401k-ira-3585.html [9/6/18]
5 – cnbc.com/2018/04/26/what-to-do-with-your-401k-when-you-change-jobs.html [4/26/18]