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IRA vs. 401(k): Which Is Right for You?

Are you interested in saving for retirement but don’t know where to get started? Many employers offer a retirement savings plan such as a 401(k), but if this option isn’t available to you or you want to do more to plan for retirement, you can look to other options. For this reason, many people use individual retirement accounts (IRAs) as part of their retirement savings plan.

Key Takeaways

  • There are two types of IRAs: Traditional and Roth.
  • It’s common for employers to offer a 401(k) or other sponsored plan, with some matching contributions up to a certain amount.
  • Both IRAs and 401(k)s have annual contribution limits.

Here’s a look at the differences between IRAs vs. 401(k)s.

What is an IRA?

An IRA is designed specifically for retirement savings. Unlike other accounts, IRAs offer certain tax advantages. There are two basic types of self-directed IRAs, each with their own unique benefits.

1.Traditional IRAs

A Traditional IRA lets you save money on a tax-deferred basis. This means you don't pay taxes until you withdraw funds from the account. As long as you have an earned income and are younger than 70 ½ years old, you can contribute to a Traditional IRA.

When you turn 59 ½ years old, you can begin withdrawing funds from your Traditional IRA. You can also leave the funds in place until you’re 70 ½, when you are required by law to withdraw minimum distributions. Since you didn’t pay taxes on the funds before, you will pay taxes on each individual disbursement.

Some people can take a full deduction up to their contribution limit. However, there may be exceptions based on your adjusted gross income, other retirement accounts — including a 401(k) — and filing status. IRA deduction limits can change annually based on IRS rules. Those without employer-sponsored retirement plans should speak with a tax professional about how these rules may affect them.

If you do have a 401(k) or similar plan, you can deduct all or part of your IRA contributions as long as your modified adjusted gross income falls under the level set by the IRS. Keep in mind this level may be adjusted annually.

2.Roth IRA

If you open a Roth IRA account, contributions are made after taxes, so you can’t deduct them or receive immediate tax savings. One benefit of Roth IRAs is that unlike Traditional IRAs, Roth IRAs don’t have an age cap of 70 ½ for contributions, nor do they have disbursement requirements.

You can open and contribute to a Roth IRA at any time as long as your earned income falls below IRS thresholds. (These change annually, so check with the IRS to find the current levels.)

Since you already paid tax on the money you used to fund the account, the tax savings will materialize when you withdraw the funds as you don't pay taxes on your contributions or earnings. If you’ve had your Roth IRA for a minimum of five years and are at least 59 ½ years old, you can withdraw without penalty.

You can also choose not to withdraw your funds at all. This means you could leave some or all of the money in your Roth IRA to pass on to your heirs. If you’re interested in this option, speak with a financial professional to learn more about the requirements and find out if it’s best for you and your family.

How does a 401(k) work?

A 401(k) is a retirement savings plan sponsored by your employer in which the company typically matches your contributions up to a certain percentage of your salary. For example, your company may match any contributions you make up to 5% of your salary; to make the most of this savings program, you would want to contribute at least the maximum amount matched annually. Speak to your HR department to find out more about the 401(k) program offered by your company.

How they work together for you

Participating in your employer’s 401(k) plan is an excellent way to start saving for retirement. But if this option isn’t available to you — or you want to contribute more to your retirement outside of your 401(k) — consider opening an IRA. The chart below can help you compare the advantages of 401(k) plans, Traditional IRAs, and Roth IRAs so you can learn how each benefits you.

The Differences Between an IRA vs. 401(k)

 

Traditional IRA

Roth IRA

401(k)

Sponsored by employer?

No

No

Yes

Employer could match contributions?

No

No

Yes

Contributions eligible for tax deductions?

Yes

No

Yes

Funds taxed upon withdrawal?

Yes

No

Yes

Annual max contribution*

$5,500

$5,500

$18,500

Annual max contribution after age 50*

$6,500

$6,500

$24,500

*Subject to change based on IRS rules. Amounts accurate as of January 1, 2018.

More information

Everyone has their own expectations and goals for retirement. To learn how we can help you prepare for the retirement you want, schedule a Citizens Retirement Checkup® at your nearest Citizens Bank branch.

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