It is important to plan for your retirement, particularly if you are starting to approach retirement age. Having a sound retirement plan in place can be the difference between a comfortable retirement and a much more challenging retirement. You have a number of options when it comes to retirement plans. Two of the most common options for retirement plans are an IRA and a 401(k).
Since these two retirement plans are so common, it is necessary to compare them and examine their similarities and differences. Comparing an IRA vs. 401(k) retirement plan can help you decide which is best for you. Keep reading to learn about the similarities and differences between an IRA and a 401(k) as they pertain to retirement.
Similarities and Differences Between AN IRA and a 401(k)
The main similarity between a 401(k) and an IRA is that they provide you with useful tax benefits. You can typically contribute to both accounts. The primary difference between an IRA and a 401(k) is that your employer offers you a 401(k) and you simply contribute to your 401(k). You set up an IRA on your own, typically via either a bank or a broker.
You can have both an IRA and a 401(k). If you’re choosing between one or the other, you should look into how your employer operates as far as matching 401(k) contributions go. If your employer doesn’t match 401(k) contributions as much as you would like, an IRA might be the better retirement plan, at least at the start of planning for retirement.
What Is an IRA?
It makes sense to clarify what an IRA is before comparing it to a 401(k). Simply put, an IRA is an account that you set up at a financial institution like a bank that lets you save for retirement in a tax-deferred way or with no taxes on the growth of the account. There are three types of IRAs: traditional IRA, rollover IRA, and Roth IRA. A traditional IRA means that you contribute money you might have the ability to deduct when it comes to your tax return.
You might end up in a lower tax bracket than you were in before your retirement. Your IRA’s tax-referral means that the money in your IRA might be taxed at a lower rate. A rollover IRA is another type of IRA. If you have a rollover IRA, you contribute money that has rolled over into the rollover IRA from some other kind of qualified retirement plan.
Rollover IRAs involve you moving eligible assets into your IRA from a retirement plan sponsored by your employer. A 403(b) and a 401(k) are two examples of retirement plans. The third primary type of IRA is a Roth IRA.
If you have a Roth IRA, it means that you contribute money that has already been taxed. This money is known as after-tax money. Your money may be able to grow tax-free and you may have the ability to make tax-free withdrawals during your retirement. You do have to meet certain conditions, though.
What Is a 401(k)?
You should also know the details of what a 401(k) is, as well. A 401(k) is a type of retirement plan that many employers offer and this plan offers you certain tax advantages. The 401(k) gets its name from a section in the United States Internal Revenue Code.
You choose to have some percentage of every paycheck deposited into an investment account. Your employer can then match all of your contribution or part of it. You choose your investment options and these investment options are typically mutual funds. The two types of 401(k)s are Roth and traditional.
You contribute after-tax income to Roth 401(k)s. By contrast, you contribute pre-tax income to traditional 401(k)s. Any withdrawals you make from a traditional 401(k) are taxed, too.
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