Originally published on: July 31, 2017
Retirement Savings Identity Crisis: 401(k), IRA or Both?
401(k)s are gaining more popularity than avocado toast with young employees these days. According to the Investment Company Institute, 401(k) plans contained about $3.5 trillion in assets in 2012, more than doubling from $1.6 trillion back in 2002.
Most working Americans look at their company’s 401(k) as the most straightforward way to go for investing in retirement savings. But another savings mechanism, the individual retirement account (IRA), offers some attractive benefits as well, particularly if you are coupling them with your existing 401(k).
In a nutshell, here’s the difference:
· A 401(k) is a defined contribution pension plan, provided by an employer. Depending on the employer, the contribution made by an employee may be matched equally or to a certain extent. The savings are tax-deferred until the post-retirement withdrawal.
· IRA stands for Individual Retirement Account and can be either “Traditional” or Roth. Typically, IRAs are invested in mutual funds. Contributions to Traditional IRAs are tax-deductible, but the distributions are taxed. Roth IRAs’ contributions are made after taxes, but the subsequent distributions are tax-free.
So, what’s the best strategy—401(k), Traditional, or Roth IRA? You may benefit from having a combination of both a 401(k) and an IRA for more flexibility tax-wise in retirement. Remember, Roth IRAs’ distributions are not taxed. Since your tax bracket in retirement may be different than it is now, having some diversity could be an advantage.
Keep These Restrictions in Mind
In 2017, the maximum to contribute to your 401(k) is $18,000 if you’re under 50, and $24,000 for those 50 plus. For IRAs, the under-50 crowd can contribute up to $5,500 in a Roth or traditional IRA, and $6,500 for 50 plus.
Be aware that if you’re contributing to a 401(k) or other employer plan and decide to open an IRA (Traditional or Roth) for additional savings, you may not be able to deduct that chunk of savings from your taxes, depending on your income. If you have no retirement plan at work, and you make more than $186,000 (filing jointly married), your deduction will be limited. If you have an employer plan, limits are imposed if you make more than $99,000 (filing jointly married).