Most of us look forward to retirement, but unfortunately it appears that Social Security funds alone won’t cut it once you’re ready. We’ll explore why in a different article, just know that for now your two main options for retirement savings are a 401(k) plan or an individual retirement account. Different situations benefit from different retirement accounts, so we first need to understand what the differences are between the two, then we’ll examine the pros and cons of each.
An IRA is a long-term retirement savings account and there are several types to choose from based on your needs. They’re called SIMPLE, Roth, SEP, and traditional IRA’s. While there are tax advantages to an IRA, withdrawing money early - prior to age 59 ½ - can have heavy tax implications. Usually, it’s a penalty of 10% of whatever you withdraw unless the reason is a qualified exception.
IRA’s also have required minimum distribution rules that state traditional IRA holders must take a specified amount out of their IRA each year after age 72 or face a hefty penalty. IRA’s can be opened at most banks, credit unions, or brokerage firms.
A 401(k) is an employer-sponsored retirement savings account. Because of this, employees can have a percentage or dollar amount of every paycheck contributed into the account each pay cycle. Many employers also offer matching programs where they will match your contributions up to a certain point, which adds up significantly over the long run.
401(k)s come in two main types: Roth and traditional. Roth contributions are made with after-tax income, so while they don’t offer a tax deduction now the money gets distributed tax-free when you withdraw it. On the other hand, traditional contributions are pre-tax and reduce your taxable income, but will be taxed when you make withdrawals. If offered, these accounts are typically set up within the first 30-90 days of employment.
To recap, both IRA’s and 401(k)s are valuable and important retirement savings account options, each with their own advantages. Here’s a quick summary of the main differences:
Still not sure? The good news is you can always contribute to both. In fact, doing just that is often encouraged in order to maximize both your savings and the tax advantages these accounts can provide.
OMB and its affiliates do not provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decision. Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value. This material is not intended as a recommendation, offer or solicitation for the purchase or sale of any security or investment strategy.
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