Familiarize Yourself with the Differences Between a 401(k) and an IRA
When it comes to planning for retirement, both 401(k)s and Individual Retirement Accounts, commonly known as IRAs, offer terrific benefits. And, guess what? You can contribute to both at the same time.
Typically, folks first get any 401(k) company match they can, then max out their IRA or Roth IRA to maximize returns and minimize costs. The main difference between the two types of accounts, of course, is that employers offer 401(k)s while IRA accounts are opened by individuals, usually through a brokerage account. If you are fortunate, you might have to choose whether to start with a 401(k) or an IRA.
Here is a short breakdown between the two retirement plans:
- A 401(k) is a retirement plan option that is only available through your employer. Eventually, the account will have to be rolled over into an IRA once you are no longer with that employer, or into another employer’s 401(k) plan. 401(k)s should always be optimized, as most employers often match a portion of your contribution. It is always recommended to at least contribute the amount that your employer will match. With a 401(k), the maximum annual contribution is much bigger than an IRA ($19,500 vs. $6,500 in 2020).
- An IRA is a tax-advantaged plan that individuals use to earmark funds for retirement savings. An IRA must be opened with an institution that has received IRS approval to offer these accounts. While choices include banks, brokerage companies, federally insured credit unions, and savings and loan associations, most individual investors open IRAs with brokers. With a self-directed IRA, you will have access to many more investment options than a 401(k), including stocks, bonds, ETFs, and mutual funds.
So, how do you choose? We might suggest this quick answer:
If your employer offers a 401(k) with a company match, contribute enough money in to get the maximum match. If your employer does not offer a company match, start with an IRA to gain access to a large selection of investments; after contributing up to the IRA limit, fund your 401(k) for the pre-tax benefit it offers.
With so many options, it all can become rather confusing. But knowing the basics can help make things a little clearer. And there is a wealth of advice available to you on how to start and manage your plan. Check out Shelton Capital’s library of 401(k) Educational Videos to help you make good choices and stay on a good retirement track.
Here’s to your success!