The 401 (k) is simply objectively better. Both 401 (k) and IRAs offer valuable tax benefits, and you can contribute to both at the same time. The main difference between 401 (k), s, and IRAs is that employers offer 401 (k), s, but individuals open IRAs (using brokers or banks). IRAs generally offer more investments; 401 (k), s allow higher annual contributions.
But as positive as all of this is, there are good reasons to have an IRA in addition to your 401 (k). An IRA not only gives you the opportunity to save even more, but it may also give you more investment options than in your employer-sponsored plan. And if you have a Roth IRA, there’s also the option to earn tax-free income later. Whether a 401 (k) or an IRA is better for an individual depends on the person.
A 401 (k) makes it possible to deposit more money before taxes each year than with an IRA. However, an IRA tends to offer more investment options, which allow greater control and flexibility over the account. Note that a person can have both. A 401 (k) is a better option than an IRA if you want to invest more for retirement and aren’t too picky about investment options.
Most plans are limited to which securities (such as stocks and bonds) the employer selects. That’s because withdrawals from a traditional IRA are taxed at normal income tax rates at the time they are paid out. Qualified Roth withdrawals are tax-free, as mentioned earlier. So use all the savings and investment tools available to you, including an IRA and your 401 (k), to save as much as you can as early as possible while getting the maximum tax break. Most IRAs and 401 (k) s do not allow withdrawals until the owner reaches the age of 59½. Otherwise, a tax penalty will be imposed by the Internal Revenue Service (IRS).
An IRA could be better than a 401 (k) if you’re looking for more flexibility with your retirement plans. If your 401 (k) offers limited investment options, consider opening either a traditional IRA or a Roth IRA and depositing the maximum annual amount. After you’ve contributed up to the IRA limit, think about funding your 401 (k) for the associated pre-tax benefit. Remember that if your income exceeds certain thresholds and you or your spouse invest money in a workplace plan, your ability to deduct traditional IRA contributions may be reduced or omitted altogether.
Because a 401 (k) is an employer-sponsored plan, you may have fewer options to choose your investments, but your contribution limits are much higher than with a traditional IRA or a Roth IRA. However, every IRA has an income cap that determines whether one or the other is right for you. Importantly, unlike 401 (k) plans, you can’t borrow from the IRS against the balance in your IRA account. Even if you’re not eligible to deduct your traditional IRA contribution, you can make non-deductible contributions and still benefit from tax-deferred investment growth.
Not all employers offer a 401 (k) plan, so an IRA is one of the best alternatives to help you save for retirement on your own. Once you’ve received the match, consider maxing out an IRA for the year, go back to 401 (k) and resume contributions there. Many 401 (k) s have a vesting period for related contributions, but SEP and SIMPLE IRAs are 100% activated as soon as a contribution is made.
.
