Differences Between 401K and IRA

by Josh Biggs in Finance on 22nd October 2020

While there are a lot of retirement options out there right now, the one common truth is that social security will not be enough to live on. If you have the chance to set up a 401k or any form of IRA, experts recommend that you start early.

Compounding Works For You

A small investment made early and compounded over time can grow to be much larger than a big investment that’s not given much time to grow. You can’t withdraw your 401k or IRA funds until 59 1/2 years old without penalty or special circumstances, so it may seem foolish to contribute to these accounts at 25. However, the sooner you start, the sooner it can grow.

Focus On the Long-Term

If you study the stock market every day, the idea of investing in stocks can make you a little nervous. However, over the long term, the stock market gives you the chance for gains. Early on, you can be a bit more adventurous. As you get older, you’ll want to find funds that are less likely to suffer big losses as you approach retirement.

Watch for the Match

If your employer offers a match, make sure you contribute enough to fully capture the entire match. Now is not the time to leave money on the table or to turn down a raise. For those with a low tolerance for risk, using the employer match to make some more daring investments can increase your final balance without adding too much to your stress levels.

Full Vs. Part Time

According to the experts at SoFi Invest, “many employers will offer a 401k to full-time employees but may not offer them to part-time or 3/4 time employees.” When comparing a 401k vs IRA, carefully review the fine print of any job offer you receive to make sure you’re continuously contributing to your retirement.

On Your Own

A 401k contribution is taken pre-tax; you don’t need to include this income in your taxable income when you file your tax returns. Setting up an IRA means you won’t have an employer match, but you will get a tax break for dollars you contribute to a traditional IRA.

Tax Considerations

When you take money out of any pre-tax investment account, you will need to pay income tax on it. It’s important to note that the assumption is that your income will be lower in retirement, so the tax burden won’t be as severe. That being said, because we don’t know what will happen with inflation or income tax rates in the future, the more you can put away now and access later, the better off you will be. You will not be taxed on the full amount of your retirement accounts, only on what you take out.

If 2020 has taught us anything it’s that we will never regret having some money in savings. A 401k savings plan means that the money comes out of your paycheck before you see it and is immediately invested for your future.

Categories: Finance