IRA Vs. 401k – What’s the Difference & Which One Should You Get?

Planning for retirement is one of the most crucial things we have to do in our adult lives. After all, there will come a point at which we will need to stop working, and we want to spend the years after that in financial comfort and stability. That, however, is impossible if we don’t save right now. So, focus on saving in the present so as to create a better future. It is a story as old as time, and we are all very much aware of the significance of saving today with the aim of designing a better tomorrow.

The question is, therefore, not whether we should save or not. Instead, the question is how to actually save. And, the answer to that may not be as easy as you may have thought, but not because there are no proven methods that will lead you towards accumulating the wealth you are after, but specifically because there are different methods. That is, there are different types of accounts that you can rely on when you want to save for your retirement.

The 401k and the IRA are among the most popular account types, and they are often the two that people sort of choose between. They are the two accounts that people have to get acquainted with so as to decide which one may be better for their specific situations. Given that you are here, I think it is safe to say that you have also become interested in understanding these retirement account options better and then finally making your choice regarding which one you want to use. And, that’s precisely what you will do if you read on.

What we are going to do today is help you get a better understanding of the 401k and of the IRA respectively. Then, we will proceed towards summing up the main differences between the two accounts, so that you can finally get the answer to the question of which one you should actually get. Of course, this will ultimately be your decision to make, but understanding the different accounts and the different ways in which they function is bound to help you make that final choice. So, without any further ado, let us start the learning process.

What Is a 401k?

Let us begin with the 401k, shall we? This is probably one of the most talked about accounts, and there is no doubt in my mind that you’ve heard of it already. In fact, you may even have some ideas about what it is and how it functions. But, chances are you are not completely sure you know everything, so it is time for you to learn the ins and outs of the account, so as to be able to ultimately decide if it is right for you.

So, a 401k is basically an employer-sponsored retirement savings account, and it is offered by companies to their employees. Basically, it allows employees to contribute a portion of their pre-tax income to retirement savings. The maximum contribution limit for this specific account depends on your age, and it is $20,500 if you’re under 50, and $27,000 if you’re over 50. The contributions are made through payroll deductions and they are potentially matched by employer contributions.

Now, these account types usually offer a selection of investment options that are chosen by the employer. They can include company stock, mutual funds, as well as target-date funds. This means that the employees have limited control over the investments they are making, which is a bit different than what you can expect from an IRA. But, we will get to that part a bit later.

You’re probably wondering about the taxes when it comes to this particular account and the contributions you can make, so let me explain what happens. Basically, the contributions are made with pre-tax dollars, which is a good thing, as it reduces the taxable income for that year. Then, the earnings will grow tax-deferred, and the withdrawals are ultimately taxed as ordinary income.

Speaking of withdrawals, there is another crucial thing to know here. In simple words, there is a penalty if you withdraw before the age of 59½. Of course, some exceptions do apply here, such as qualified distributions for specific purposes, as well as hardship withdrawals. In most situations, though, you will need to pay a 10% penalty if you withdraw early.

What Is an IRA?

Now, let us proceed to the IRA. Once again, this is definitely an account you’ve heard of already, and you’re bound to have some info regarding how it works. It is, however, time for you to get even more info and completely understand the way this retirement savings account functions, so that you can later compare it to the 401k and decide on the one that’s best for you. Thus, let’s get your facts straight.

Basically, IRAs are tax-advantaged accounts that individuals can set up on their own, outside the employer sponsorship. It is a very popular option nowadays given that it offers numerous types of investment opportunities, thus providing individuals with higher control over the assets that go into their portfolios and out of them. There are stocks, bonds, ETFs, and numerous other options that allow you to customize your investment strategy based on your specific financial goals and your risk tolerance.

Additionally, people also have the opportunity to invest in gold and other precious metals through a specific type of IRA, called a self-directed one, or a SDIRA. This is another highly beneficial option that people are increasingly going for these days, due to the economic instabilities and the volatility of other types of assets, compared to the stability in value of gold and those other precious metals. So, if your goal is to go for those alternative investment opportunities, you should definitely give IRA a chance.

It is also important to mention that there are various types of IRAs out there, with the Traditional and Roth IRAs being the most popular, apart from the SDIRA, of course. With the Traditional IRA, the contributions are tax deductible and earnings grow tax-deferred, and with Roth IRA, they are made with after-tax dollars, with earnings growing tax-free until withdrawal. The maximum contributions are lower than with the 401k, standing at $6,000 for people under 50, and $7,000 for people older than 50.

What Are the Main Differences?

Let me now sum up the main differences between these two accounts, some of which you can read about on this website in more details. First off, the 401k is offered by employees, while the IRA is opened by the individual him or herself. The contribution limits are higher with the 401k, but the IRAs offer more investment options and assets, including those alternative ones, such as precious metals and even cryptocurrencies. So, the IRAs offer more control over your portfolio.

Which One Should You Get?

Both of these accounts offer valuable opportunities for retirement savings. Your decision will depend on your specific circumstances, as well as your financial goals. So, this is a decision that only you can make for yourself. What I can say, though, is that a lot of people are opting for IRAs due to the greater control that it provides over their investment portfolios. Ultimately, though, it is up to you.