Everything You Need to Know About an IRA vs 401k
401k plans and Individual Retirement Accounts, also known as IRAs, are the most popular options for saving for retirement. Both paths are great for retirement because of what they have to offer in terms of tax benefits, however they have a few crucial differences that can have a significant impact on how much you will end up with after taxes.
The first difference between a 401k and IRA is how to open an account. A 401k plan is established by an employer, while an IRA is established by an individual. Each employee decides whether to put a portion of their pay into the plan, while the employer has the option to match or contribute some portion as well. All employee contributions are held in a single plan trust, but each individual has a separately tracked account balance. One of the most appealing benefits of a 401k is the employer match, which is essentially free money. If your employer offers any kind of match it is almost always worth it to contribute to your 401k.
An IRA however, is an individual account that is not associated to any employer. Individuals are free to contribute a portion of their earned income to an IRA up to a certain amount annually depending on a few factors. There are multiple types of IRAs and we will go into detail on how these differ below. An important note about IRAs is that there are typically income limits which prevent you from contributing once your income reaches a certain point, as well as the contribution limits noted above.
Something else to keep in mind, you can contribute to both a 401k and an IRA! If your employer matches contributions into your 401k, that is free money that you should definitely take. If you want specific tax advantages an IRA may also make a lot of sense, and it is common for individuals to make contributions to both accounts.
Types of IRAs
The type of individual retirement account (IRA) that you start now can have a significant impact on the amount of money you will have in retirement. It's worth learning the differences and optimizing you contributions, gains and withdrawals to minimize the amount you owe in taxes.