Individual Retirement Accounts (IRAs) and 401(k)s can both be great tools to help you build your retirement savings, but each has rules and restrictions you need to be aware of. As you create your savings plan, here’s the basics so you can decide what combination of accounts is the best fit for your situation and goals.
A 401(k) is a retirement plan offered by employers. Certain tax-exempt employers, like public schools or the government, offer a similar retirement plan, but it is called a 403(b).
The advantages of 401(k)s are that they don’t require you to do much, if any, management, and they often come with an employer match. That’s basically free money! All you have to do to earn it is save towards your retirement in this account. If you aren’t sure if your employer offers a match or what you need to do to enroll, talk to your supervisor or your HR department. 401(k)s also have high contribution limits. Workers under 50 can contribute up to $19,500 every year and workers over 50 can go up to $26,000. That limit does not include employer contributions. So, if you’re behind on your retirement savings or have more to save, a 401(k) might be a good option.
On the downside, not everyone has access to this type of account. There are some companies, generally smaller ones, that do not offer a retirement savings plan as an employee benefit. If you are self-employed, you can set up a Solo 401(k) but you would be responsible for all the management and both the employee and employer contributions. The withdrawals on a 401(k) can also be confusing. Most retirement accounts don’t allow withdrawals until age 59 ½, but 401(k)s include other “distribution events” like switching jobs that need navigation to avoid tax penalties.
An IRA is a personal retirement account that you can open through an investment group or a financial institution.
IRAs are not connected to your employer, so if you change employers, work for a smaller business, are self-employed, or are between jobs, you can still use an IRA and you don’t have to worry about changing it. There’s also more freedom with an IRA. You can choose when and where you want to invest your savings rather than having your employer make that decision.
However, IRAs have lower contribution limits than 401(k)s; only up to $6,000 for people under 50 and $7,000 for those over. They also have similar tax penalties for withdrawals made before the owner is 59 ½, but as they are personal accounts you don’t have to navigate any possible taxes when switching jobs.
Retirement savings accounts can be complicated. If you have questions about what 401(k) options are available to you, talk to your supervisor or your HR department.