As the go-to investment option for most companies and their employees, 401(k) plans provide many benefits to plan participants, including deferment of taxes, the likelihood of an employer match, and a high maximum allowable for annual contributions.  But for those that are self-employed, or whose employer does not offer a 401(k), a traditional or Roth IRA is an option.

In many ways, a 401(k) and an IRA are similar in scope, with contributions for both accounts made pre-tax, reducing taxable income for the year.  A Roth IRA is different, with contributions made using funds that have already been taxed. While taxable income remains the same regardless of contribution levels made, the key benefit of a Roth IRA is that withdrawals are tax free.  One of the best ways to decide between a traditional retirement plan and a Roth IRA is to estimate your future tax rate, then make the decision accordingly. If you believe that your tax rate will be higher when you retire, you may want to go with a Roth account, since any withdrawals are tax-free.  If you believe your tax rate is currently as high as it will go, it may be best to go with a 401(k) or traditional IRA, which will eliminate taxes now, and ensure that the lower tax rate will be used when withdrawing funds during retirement.

Of course, the good news is that you really don’t have to choose between a 401(k) and an IRA, you can contribute to both if in the position to do so. If doing so, keep in mind that you risk losing your tax deduction when your income reaches a certain level ($73,000 for a single filer, and $121,000 for married couples filing jointly.) If you choose to contribute to a Roth IRA, there is also an income limit to make contributions, with contribution limits beginning to decrease once your annual income reaches $120,000, or $189,000 for those filing jointly.  The ability to contribute to a Roth IRA goes away altogether once income reaches $135,000 for single filers, or $199,000 for married filers that file a joint return.

Flexibility can be another key concern.  For those that like to be more involved in choosing the funds that they wish to invest in, an IRA is a much better option. A 401(k) plan typically limits investment opportunities to around 20 funds, making it much more difficult to maintain control of where your money is going.

Cost can be another factor in determining what investment strategy to pursue.  401(k) plans can be notoriously expensive, with management fees accumulating over the years, while an IRA typically costs little to nothing to maintain.  

While 401(k) plans and traditional and Roth IRA plans all offer a way to better prepare yourself for the future, it’s a good idea to take a look at the advantages and disadvantages of both to see which one fits you best, both now and in the future.  The most important thing is that you make a commitment to prepare for your future today.

Since this information is for educational purposes, and limitations and restrictions are present for all the choices noted above, please reach out to us to discuss your specific situation.

Resources

https://www.fidelity.com/viewpoints/retirement/spender-or-saver

https://www.fool.com/retirement/ira-vs-401k-which-is-better-for-you.aspx

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2024 Advisor Websites.