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IRA vs. 401k

Retirement planning is probably not at the forefront of your mind, especially if you are a young working professional. With work, school or a busy family life to worry about, planning for the future just doesn’t fit into your day.

However, your retirement plans should take a front seat, if you hope to have a sense of financial security when you reach retirement age. It’s important to save now, so you can enjoy it later.

There is a handful of plans out there to suit your needs. From retirement plans for self-employed individuals to solo 401k accounts, you can be sure that you will find a savings plan that is right for you. Not to mention, most companies offer various types of plans to their employees, because they know not everyone is the same. Continue reading the sections below to learn more about retirement calculator tools, as well as IRA and 401k accounts.

What is a 401k?

A 401k is a retirement planning and savings account offered by employers that gives employees a tax break on funds they save for retirement. Financial contributions made to these accounts are automatically withdrawn from an employee’s paycheck, and are invested wherever he or she chooses. Most companies provide employees with a list of investment options from which they can choose.

When it comes to a 401k companies do not always offer this type of plan. If your employer doesn’t offer you a 401k, don’t worry; you have a few other options that will offer you the same type of tax break benefits. That’s where the IRA comes into play (more on that below).

There are many 401k benefits that offer incentives to employees. For example:

  • Many employers will match the contributions made by employees up to a certain amount. This is a great way to save money, as it increases the total amount saved each year.
  • Current 401k plans have high contribution limits. Employees 50 years of age or younger can contribute up to $19,000 each year. Those who are older than 50 can contribute up to $25,000 per year.

Other benefits of 401k retirement plans can be seen during tax time. Contributions lower an employee’s overall taxable income, which can save him or her a suitable amount of money in taxes. Furthermore, an employee’s eligibility to enroll in a 401k is not dependent on his or her income.

What is an IRA?

An individual retirement account (IRA) is a type of retirement planning account that individuals can set up at a bank or financial institution. They allow folks to save for retirement with tax-free growth, or by deferring taxes. There are different types of IRAs, each of which has different tax breaks.

A Roth IRA is one type of individual retirement account. Individuals make contributions into these accounts with money on which they have already paid taxes, otherwise known as “after-tax” money. The incentive of a Roth IRA is that money will grow in the account tax-free, and can be withdrawn tax-free during retirement.

Wondering how to open a Roth IRA? The process is quite simple. After researching various financial institutions and choosing a bank, you can open your account online or in-person. You must provide all required documents and information, so the bank can determine your eligibility. Then, you choose where to invest your funds, and set your annual or monthly contribution schedule. Additional notes on IRAs include:

  • Traditional IRA retirement plans allow individuals to make contributions with funds that they can deduct on their tax returns.
  • Earnings in the account can grow tax-deferred, until they are withdrawn in retirement.
  • During retirement, the money will likely be taxed at a lower rate than it would have been during the individual’s working years.

What is a Solo 401k?

Retirement plans for self-employed individuals are available from a variety of brokers. These are known as solo 401k plans, and are designed for contributions made by one individual. To qualify for this type of plan, individuals must be self-employed, have no employees and have a tax identification number.

While the plan is not designed for business owners who have employees, it does cover one self-employed individual and his or her spouse. Self-employed workers can make contributions into a solo plan with many of the same features and benefits that employer-sponsored plans have.

Solo 401k plans have contribution limits of $56,000 per year, with a $6,000 catch-up contribution for those who are 50 years of age or older. These plans also come in traditional and Roth plans, which helps self-employed individuals find the best investment options.

The drawbacks of retirement plans for self-employed citizens include strict penalties for withdrawing early. For example, withdrawing from a solo account before the age of 59-and-a-half requires tax payments and other fees. Likewise, in order for a spouse to be covered by this type of plan, he or she must earn income from the business of the applicant.

A solo 401k retirement plan is not the only plan available to self-employed individuals. They may choose to open an IRA, Roth IRA or other type of plan if they feel it fits their needs. They may even have two types of plans open, and make contributions to both.

How do I choose?

Use a retirement calculator to estimate your contribution limits for the upcoming year. This is the best way to determine how much money you can set aside for retirement, which will help you find the best IRA accounts or savings plans available.  

While choosing between a 401k and a Roth IRA is an individual choice, there are ways to find the best plan. If your employer offers to match your 401k contributions to a certain limit, you should contribute until you receive the maximum amount of matching dollars. After that, consider investing the rest of your savings for the year in an IRA.  

If your employer does not match your retirement planning contributions, invest your first money into a Roth IRA or traditional IRA. Once you reach your IRA contribution limits, begin funding your 401k account. Following these guidelines will help you receive the most amount of benefits allowed by these plans.