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401(k) vs Traditional IRA: What is The Best Retirement Account for You?

401(k) vs. Traditional IRA: What is The Best Retirement Account for You?

By Les Stephen

This is a loaded question because although there is some common ground, they are two entirely different animals.  The main difference between the two types of accounts is that a 401K is considered an employee sponsored plan provided by your employer, while Traditional IRA accounts are opened by individuals generally through their broker or even at a bank.  If you are wondering which one to choose, I have good news. It is possible that you can have both.  There are however certain income limits, so always check with your financial advisor before making any decisions.  It would probably be best if we discussed these two styles of accounts separately so we can examine the differences.  Also, there are many aspects to these types of accounts and below are just a few of the highlights.  

What is a 401k? 

A 401k is an employee sponsored plan that is generally offered to its employees as part of their benefit package.  Here are a few advantages.  A 401k is deducted from your paycheck, so it makes it effortless as a participant.  The funds grow on a tax deferred basis.  The contributions you make decreases the amount of taxable income that you have to report each year.  A majority of companies have some type of matching program to the employee’s contributions. The limits are higher than those allowed in a Traditional IRA. 

Although the plans are great, there also some downsides.  Most 401k’s have a limited amount of investment choices inside the program itself.  Because you have not paid taxes on these funds, they become taxable when they are taken out. There are also penalties if withdrawn before the minimum age set by the government.  

What is a Traditional IRA

As pointed out earlier, Traditional IRA’s are opened by individuals usually by their broker or at their bank.  One big advantage is that there is a wide variety of investment options available including stocks, mutual funds, ETFs, bonds, CDs, annuities, etc.  When one stays under the income limit, the contributions can be deducted from your gross income to help with taxes.  The funds also grow on a tax deferred basis.

There are a few downsides to this program also.  One of the biggest issues is that the limits are low so it might be tough to get to your retirement goal with only a Traditional IRA.  They are also subject to penalties for early withdrawal and are taxable upon distribution.  

Below are the current 2020 IRA limits.  Remember, they may and often do change from year to year.

                                                                IRA                      401k

Basic limit                                                       $6,000           $19,500

Catch-up limit if 50 and older                      $1,000            $6,500

Total limit for those 50 and older              $7,000           $26,000

 

Not to make things even MORE complicated but there are also ROTH 401k’s and ROTH IRA’s.  This is why I continue to recommend that you seek advice from an investment professional because everyone’s situation and investment is different.   Hope this helps and thanks for reading.  

 

If you are looking for a financial advisor team focused on your unique financial situation, communicates openly, and that puts you and your goals at the center of the relationship, call us at (480) 507-2425 or contact us online. We’d love to meet you. 

 

The content in this article was prepared by the article’s author. Voya Financial Advisors, Inc. does not endorse its content, and the views expressed may not necessarily reflect those held by Voya Financial Advisors, Inc.