Written by 401k vs IRA, which should you choose? Before we answer the question, let’s start with defining a 401k and IRA. IRA stands for Individual Retirement Account. Both your 401k and IRA are pretax retirement vehicles. Which means you invest your money in both accounts before it is taxed. That also means your investments will be taxed whenever you withdraw the money from your accounts. They both have an early withdrawal penalty if you access your money before 59 1/2.
When deciding between a 401k and traditional IRA, there are four things you need to understand.
1. Customization
If you were interested in choosing between stocks, mutual funds and EFTs, then the IRA is going to be a better option for you. A typical IRA is going to have thousands of stocks to choose from. If you were going to open your own IRA at your brokerage or through your advisor, you can basically choose any stock you like. It would feel like an endless supply of stocks, mutual funds and ETFs available to design your portfolio.
Customization is limited when it comes to what you’re able to do with your 401k. 401k’s usually have around 10-15 choices. They will offer you a couple conversative, several moderate and a few aggressive investments. That is all 401ks providers are required by law to make available. As a result, the customization between the 401k vs IRA is evident. If customization is a priority for you, then the IRA is your best choice. If you are looking for something more turnkey, then the 401k is simpler and likely a preferred choice.
2. 401k vs. IRA contribution limits
For those with excess disposable income, their interest lies in the contribution limits. Those with a 401k are allowed to contribute up to $20,500 per year. If you have an IRA, your contribution limits are $6,000 per year. If you have the ability to contribute more than $6,000 per year, then the 401k is going to be a better option.
3. Ability to open account
Your 401k is offered through your employer. Which means you must work at the company to put money into your account. If you switch jobs, you can no longer contribute or change your investment strategy within that 401k. Now, you can move the money from your previous employer to your new employer if you want to continue funding the account. However, if you leave the money at your previous employer, you can no longer add additional funds. The money will sit there and hopefully continue growing, but you make any adjustments to the account.
This can become a problem as the Bureau of Labor says we will average 12 jobs over our lifetime. If you don’t move your accounts to your new employer each time, you may find yourself with 12 different 401k accounts to manage in retirement.
What if your job doesn’t offer a 401k?
For those who work somewhere that does not offer a 401k, then the IRA is your only option. The IRA is for anyone who has an earned income. If you earn an income, then you can open an IRA at any brokerage and contribute the $6,000 per year previously mentioned. A less known benefit of an IRA is that the spouse of an income earner can have their own IRA too. Even if the spouse is not an income earner, they can have their own IRA account.
You won’t find that benefit within a 401k. The 401k is a perk of working at a particular company. If you don’t work there, you cannot have a 401k. Therefore, when you are comparing the access of a 401k vs IRA, the IRA is more accessible.
4. Show me the free money
Who doesn’t want free money? How would your day change if you found $100 under your car seat? That feeling of “pleasant surprise” is only found within a 401k. There are a variety of matches companies will offer their employees to participate in the 401k. The match is usually 2$-4%. Where most companies will match your contribution dollar for dollar up to a certain percent. Companies can get creative and offer half a percent for every percentage you contribute up to a certain amount. Either way, you have access to free money. Your IRA on the other hand is just your money. The money in your account is 100% derived by the money you contributed and the performance of your investments. If you are looking for free money, then your 401k wins this 401k vs IRA match.
Free has a cost
Typically, you can expect the fees for your IRA to be lower than the fees within your 401k. 401k’s have investment fees, administrative fees, fiduciary fees and consulting fees. These fees can eat into your returns and should be something you keep an eye on. As long as you aren’t actively day-trading your IRA at your brokerage, you should typically expect the fees from your IRA to be lower than your 401k.
Final thoughts
When comparing a 401k vs IRA, there are many factors to consider. As a result, we tend to use both when possible. Contribute to your 401k up to the match to access the free money. As you change jobs, roll your previous money into an IRA. Then you can customize your IRA and further diversify your investments. For those who need larger contribution limits, then having both a 401k and IRA will help you achieve your retirement goals.
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