If you’re budgeting for retirement, you may be wondering, “What’s the difference between a 401k and an IRA?” The main difference is that a 401k plan is set up by an employer, while an IRA is an individual account. Learn more about how a 401k vs. IRA compare and which is the better investment choice for you.
What is an IRA?
An IRA (Individual Retirement Plan) is established with a financial institution and allows you to save funds for retirement with tax-free growth or with deferred tax. There are three main types of IRAs:
- Traditional IRA: Generally, the contributions you make are tax-deductible and reduce the amount of taxable income during each contribution year. Your investment earnings aren’t taxed until they’re withdrawn from your account.
- Roth IRA: Contributions are made with money that has already been taxed. Provided certain requirements are met, your investment earnings may become tax-free even after withdrawal.
- Rollover IRA: Contributions are made with money that rolls over from another valid retirement plan, such as a 401k. A rollover IRA functions as a traditional IRA.
The largest drawback to an IRA is strict contribution limitations. Contributions are limited based on age and income. For example, you can no longer make contributions to a traditional IRA after age 70 ½, unless you have a Roth IRA. Even so, if your modified adjusted gross income (MAGI) exceeds a certain amount, you won’t be able to contribute to a Roth IRA at all.
What is a 401k?
Many employers offer a 401k, which is an employer-sponsored retirement plan employees can make tax-deferred contributions to from their earnings. 401ks are one of the most popular types of retirement plans. Plan contributions are usually invested in a portfolio of mutual funds, which can include stocks, bonds, and more. Many plans offer index fund options that allow you to invest in a mix of assets.
When you withdraw your money from your 401k, it’s taxed much like a paycheck. The Roth 401k offers many of the same advantages of the Roth IRA. It allows account holders to make after-tax contributions and withdrawal funds tax-free, assuming certain requirements are met. More than half of company-sponsored 401k plans offer the Roth 401k, so it’s a viable option for many people saving for retirement.
One factor to keep in mind when considering a 401k is its limitations. These plans are highly popular, but the contributor is burdened with 100% the risk. When you’re ready to retire, the amount saved in your account is what you’ll receive as a pension (after taxes). If the funds you choose for your plan don’t perform well, there’s a risk you won’t have enough money to retire comfortably.
Learn More About Your Retirement Options with Public Service Credit Union!
If you have additional questions about how to invest in your future, contact us at Public Service Credit Union. We have branches throughout Michigan, including Romulus and Detroit. While you’re here, ask about other ways you can put your money to work for you, such as choosing a credit union.