Both 401(k) plans and IRAs offer the means to save for retirement, and many people have a 401(k) plan at work and personal IRA accounts.
If you’re comparing IRAs and 401(k)s, here are some important facts you should know, including tips on a 401(k) vs. an IRA rollover.
Assets
Individual IRAs offer access to a wider range of assets than a 401(k), where investment opportunities are limited by the employer. With an IRA, you can access CDs, stocks, bonds, and real estate opportunities that might not be in your 401(k) portfolio.
Contributions
Be aware that you can contribute much more to a 401(k) than an IRA. The annual contribution cap for IRAs is $6,000 a year, or $7,000 if you’re 50 years of age or older.
The annual contribution rate for a 401(k) is considerably higher: up to $19,000 a year, increasing to $25,000 once you reach 50 years of age. In addition, some employers match contributions to 401(k)s.
Presuming you have both a 401(k) and an individual IRA, which should you max out first?
If your employer matches 401(k) contributions
You should focus on maxing out your 401(k) plan first; otherwise, you’re losing any matching contributions. For instance, if you contribute $200 a month to your 401(k) and your employer matches funds, you’ll save for retirement much faster than if you were to contribute $200 a month to your IRA.
If your employer does not match 401(k) contributions
In this case, it’s often better to max out your IRA before contributing to your 401(k). Doing so can allow you to take advantage of the wider investment opportunities of the IRA.
401(k) rollover vs. transfer
Upon retirement, you’ll have to decide whether to keep your 401(k) vs. roll the money over to an IRA. Many people choose to move their 401(k) savings into IRAs upon retirement. There are two reasons for doing so.
By rolling 401(k) funds into IRAs, you have more investment opportunities. In addition, IRAs have some flexibility in how you can use your money without paying a penalty (for instance, you can withdraw money from an IRA for college expenses at any time without penalty).
There are two ways to transfer money from a 401(k) to an IRA: transfers vs. rollovers. 401(k) savings can also be left in their existing plan if you’re happy with the state of your retirement savings.
Transfers: You want to transfer funds without triggering a tax event, which can seriously deplete your retirement savings. The best way to do this is a direct trustee-to-trustee transfer, where the money moves directly from the 401(k) to the IRA. As you don’t take receipt of the money during the transfer, the savings are not subject to tax withholding.
Rollovers: This occurs when a company distributes your 401(k) plan assets directly to you. If this happens, you have 60 days to move the assets to an IRA or other company plan.
If you miss this deadline, you pay income tax on the entire amount and pay a 10 percent early withdrawal penalty unless you’re age 59 and a half. You can only perform one 60-day rollover every 12 months.
What about Roth IRAs?
These retirement accounts are funded with after-tax income. Unlike traditional IRAs, you pay tax upfront and don’t pay taxes on account earnings and withdrawals (if money is withdrawn after age 50 and a half). Rolling 401(k) plans into Roth IRAs can trigger tax events.
The bottom line
Get advice from a trusted financial advisor on your best course of action, and be sure to learn about retirement planning in more detail in our post on the topic.
