IRA vs 401K: Is One Better than the Other?

You may not have a choice between choosing an Independent Retirement Account (IRA) or a 401(k). A 401(k) is not an option for any individual to go open; instead, this is a company-provided account. Your employer sets up this account for employees as a benefit, and only employees of your company can invest into the account. If your company offers a 401(k) or 401(k) matching, then this choice will be superior in a number of ways to an IRA, which you set up for yourself.

Contribution Limits

A 401(k) account has a higher contribution limit on an annual basis than does an IRA account. This allows for some space for your employer to match your contributions. This means that for every dollar you place in the account up to a certain percentage, your employer will also put a dollar in for you that does not count as part of your salary. So, if your employer matches 6 percent and you earn $60,000 a year, you can actually earn $63,600 from your employer on an annual basis just by contributing to this maximum match amount. With an IRA, the contribution limit is lower. This mostly affects very high earners, but it is definitely worth considering from the beginning since your retirement account stays with you for decades.

Borrowing Funds

You cannot borrow funds from your IRA. Instead, if you needed the money before you reached 59 1/2, you would have to withdraw early and pay the 10 percent penalty. You can borrow money from your 401(k) if you pay it back within a short period of time. Since your employer actually manages this account, though, your ability to take the loan may be limited by the employer's policies. Furthermore, the loan can be used only for specific items, such as college tuition or a home down payment. 

Reduction in Management Fees

When you operate your investments from within a 401(k), you may see a reduction in management fees for those investments. For example, you can use the funds in the account to purchase shares of a mutual fund. The mutual fund may have a 2.5 percent sales charge, and this can be waived in a number of 401(k) accounts. Mutual funds intentionally offer these discounts to attract corporate individuals to their investment houses. 

Flexibility

First, it is worth noting that an IRA has the same tax status as a 401(k). Second, if you cannot access a 401(k), it is important to realize that an IRA is an extremely viable alternative. Though the limits are lower, you cannot borrow, and you may pay a little more, the IRA account is essentially the same as a 401(k) account. IRAs even have advantages when it comes to flexibility. You can decide when to contribute as long as the contribution is made before your taxes are filed. You can switch your investment options more frequently, and you can even invest in a much wider variety of securities. The IRA is truly designed for the independent professional, and its flexibility addresses the needs of independent investors. 

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