401k vs IRA
If you are someone who is looking to start a new investment account, roll over an existing account to something new, or if you are just looking to understand more about different investment accounts then you should definitely understand the main differences between 401k vs IRA accounts. Each of these accounts has different benefits and different rules to govern how you use them to invest. Here are the basics:
A 401(k) is a type of retirement savings plan named after a section of tax code; can you guess which section? This type of account arose in the 1980s as an alternative to pension programs. A 401(k) is a plan sponsored by an employer. Employees have the option to select a portion of their income to be deposited into the account before taxes are taken out. Sometimes, depending on your employer, a portion or that entire amount deposited can be matched by the employer. Taxes on the money deposited are not paid until the money is withdrawn from the account. 401(k)s and IRAs do have limits, administered by the IRS, on how much you can contribute each year. For more information on contribution limits, check out our blog post on 401K Limits for 2013.
Many 401(k) providers offer an array of Mutual funds to select from as investment choices. The mutual funds may be comprised of stocks and/or bonds and they are usually labeled as aggressive or conservative. Although a 401(k) allows you some flexibility of investment choice, it doesn’t necessarily allow you to invest in what you want since you are limited to the investment options provided by the 401(k) custodian.
401(k)s can be very advantages, especially if your employer is willing to match your deposits. However, the money you earn will be taxed once you decide to withdraw the funds. An IRA offers similar investing options but different tax benefits that can help you save money.
IRA literally stands for Individual Retirement Account, and like a 401(k), is a type of account that houses your investments. Unlike 401(k)s, which is sponsored by your employer, an IRA account is something you usually open on your own. You can still invest in different types of stocks, bonds, and mutual funds too.
The biggest differences between an IRA and a 401(k) are the tax benefits an IRA can offer. Depending on which type of IRA you use, and there are multiple types, you can avoid paying taxes a lot of taxes. A Roth IRA, for example, is an IRA in which you pay taxes when you first deposit money into the account, but you are not taxed on the gains later on. Imagine starting an account for your grandson with only $5,000 dollars today and watching it grow to $50,000 over time. If you would of opened a Roth IRA then you would only be taxed on the $5,000, talk about a HUGE savings. Now each person is different and depending on your specific situation a Rith IRA might not be the best option for you. To understand more about which type of account would be best for you, we have a tool to help you determine “What Account is Right for Me?”
401k vs IRA vs Self-Directed IRA
I wanted to briefly mention a special type of IRA called a “Self-Directed IRA.” Just like the other types of IRAs we just discussed, a Self-Directed IRA can offer many different tax benefits. However, the main difference is the types of things you can choose to invest in. A Self-Directed IRA allows you the most control over your portfolio by allowing you to invest in more than just mutual funds. You can invest in businesses, real estate, and much more. A Self-Directed IRA definitely gives you much more control over what you want to invest in. For more information on Self-Directed IRAs, head over to our “About Self-Directed IRAs”page. At the end of the day whether you choose to have an 401k vs IRA or vs a Self-Directed IRA, you should definitely do lots of research. The more knowledge you have, the smarter you will invest.