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Retirement and Aging

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Should I invest in an IRA or a 401(k)?


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Both IRAs and 401(k)s have their advantages. In order to decide which is best for you, get familiar with the basics.


401(k)s

Your 401(k) is likely offered through your employer. All of your contributions to this type of plan are made before taxes. Then, you’ll pay taxes when you start making withdrawals in retirement. For this reason, 401(k)s are usually best for those who think they will make less in retirement than they are making today.

Your investment options with a 401(k) are limited to those offered by your employer. However, your employer may match a certain percentage of your contributions. Contribute at least enough to get this match.

There are some benchmark numbers you should take into consideration:

  • How much can I save per year in a 401(k)? In 2016, you can save up to $18,000 if you are age 49 or younger. Those who are 50 and older can save up to $24,000.
  • When can I start withdrawing money without penalty? Age 59 ½.
  • Are there exceptions? Yes.
    • If you leave your employer at age 55 or after, you can start taking distributions without penalty.
    • If you are retiring from a career as a police officer, firefighter or medic, you can start taking distributions without penalty at age 50 after you have left your line of service.
    • You can also take distributions without penalty if you endure certain hardships.
    • Another option is to take out a loan against your 401(k). Generally 50 percent is permissible if paid back in five years. If at all possible, it is best to let that money sit until you retire, though. Not only is it hard to make up contributions, but in the meantime, you’ll also be missing out on the compound interest that makes investing in the market so advantageous.
    • 72(t) rule withdrawals, named for the Internal Revenue Service tax code, are penalty-free provided that you take at least five “substantially equal periodic payments” (SEPPs) in an amount determined by your life expectancy and other IRS stipulations.
  • When do I have to start withdrawing money? At age 70 ½, you must start taking required monthly distributions (or RMDs).

IRAs

The three most common types of IRAs are traditional, Roth and myRA. Each has unique features, but they all share one thing in common: contributions.For 2016, you can only contribute $5,500 to all of your IRA products combined. If you are over age 50, the limit is bumped up to $6,500. The myRA has a lifetime cap of $15,000; once it reaches this point, it will be rolled over into a Roth IRA.


 Traditional  Roth  myRA
 Are contributions made  pre- or post-tax?  Pretax  Post-tax  Post-tax
 Are there any income  limits that prohibit  contributions?  No (but there are income limits  for the deduction of traditional  IRA contributions)   Yes  Same as Roth
 What are my investment  options?  Anything available from your  brokerage  Anything available from your  brokerage  U.S. Treasury Bonds
 When can I start  withdrawing money  without penalty?  59 ½  Can withdraw contributions at any  time; withdrawals of interest will incur  penalty until age 59 ½  Can withdraw contributions at any  time; withdrawals of interest will incur  penalty until age 59 ½
 Are there exceptions?   Yes   Yes  Same as Roth IRA
 When do I have to start  withdrawing money?  70 ½  No RMDs  No RMDs
 Do I have to pay taxes  when I withdraw  money  after age 59 ½?  Yes  No  No

Do Both

After going over the basics, maybe there is one option that is better for you than the other, but there’s nothing saying you can’t do both. If you have the cash flow to fully fund both a 401(k) and an IRA, you’ll be able to reach your retirement goal faster. 

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I lost my job — what should I do with retirement accounts?


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When you lose or leave your job, you have three options with your retirement accounts. You can keep the money in your established account (which will typically be a 401(k), 403(b) or pension plan), distribute the funds (meaning that you cash them out) or roll them over into an IRA.


Keep Funds in the Same Account

If you’re happy with your current retirement account, you can leave the money to grow where it is as long as your employer allows it. If you haven’t been at the job long enough, you may not be vested and the employer will ask you to either distribute or roll over your funds.

If you are in a pension system, they may give you the opportunity to retire early. That may be a good option, but keep in mind that if you want to continue working, taking the retirement benefit will limit your job prospects to employers who do not participate in that particular pension system.

Distribute Funds

If you choose to distribute your funds, you will take the money now rather than saving it for retirement. You will have to pay taxes on the money earned as well as a tax for taking a distribution early if you are under age 59 ½.

Roll Over the Funds

Typically when you roll over your retirement account, you’ll be putting it into an IRA. This widens your investment options and allows you to choose how you want to be taxed. There are three types of IRAs.

  • Traditional IRA. A traditional IRA functions much like a traditional 401(k) as far as taxes are concerned. Usually your contributions will be taken out before taxes. Then, when you retire, you will pay taxes on your distributions. If you think you are making more money now than you will withdraw in retirement, this may be a good option for you. You cannot withdraw any money from a traditional IRA before the age of 59 ½ without incurring a penalty tax. Once you hit age 70 ½, you will be forced to take required monthly distributions (RMDs).
  • Roth IRA. With a Roth IRA, you pay taxes first and then make your contributions. When you retire, you will not have to pay taxes on distributions as long as you are past the age of 59 ½ and your account has been open for five or more years.
    However, you can take money out of your Roth IRA early without penalty, as long as you are only withdrawing the money you contributed. If you withdraw interest, you will have to pay a 10 percent tax. There are no required monthly distributions with a Roth IRA.
  • myRA. The myRA follows the same tax rules as a Roth IRA. However, you only have one investment option with this type of account: government bonds. They are an extremely safe investment, but their rate of return is low. myRAs can hold up to $15,000. Regardless of how much you save in your account, you can only have it open for 30 years max. At that point you are required to roll it over into a Roth IRA.

If you don’t feel confident deciding on your own, it can be helpful to sit down with a financial advisor who does not have a vested interest in your decision to go one way or the other.

After going over the basics, maybe there is one option that is better for you than the other, but there’s nothing saying you can’t do both. If you have the cash flow to fully fund both a 401(k) and an IRA, you’ll be able to reach your retirement goal faster.