Differences Between a 401(k) and IRA
One of the most common misconceptions we run into when meeting with prospects and clients is people thinking that they are saving into an IRA when it’s 401(k) or thinking that their 401(k) is in IRA. So today we’re going to spend a little bit of time by talking about the differences between the two.
The most commonly known retirement plan that you get through your employer is a 401K, and that’s typically what people think of. Those are employer-sponsored plans that you contribute to through your paycheck. There is a cap that you can do on them — $19,500 for this year (it does adjust, typically year to year) and then your employer has the option to match a percentage of your income or even maybe just do a flat match whether you are contributing or not. It’s normally very clearly explained to you in those documents when you first sign up for your 401(k), what their contribution match is, and also what the vesting schedule is on it.
When it comes to an IRA, that’s separate from your employer – that’s an account that you set up for yourself, an individual retirement account. It works much in the same way, as a tax-deferred account, and you can contribute up to right now $6000 a year before hitting the cap out there. Then, as with the 401(k), this also had to catch up where you can contribute additional dollars once you hit the age 50. It works much in the same way where you put in money and then you should see a deduction once it comes time to run your taxes. Another difference between the two is when you turn 72, there’s a thing called an RMD (Required Minimum Distribution) you have to take from retirement accounts.
Now with 401(k)’s, if you were still working with that employer when you hit 72, you do not have to start taking those RMD’s. So that’s where kind of weighing the risk/reward of should I roll my 401K over into an IRA if I plan to continue to work kind of comes in hand. With an IRA, as soon as you hit 72, it doesn’t matter if you’re still working or not, you’re going to have to take those distributions which are going to be taxed to you as income.
Another big difference is you can take (if they are available) a loan against your 401(k), that’s not something you can do on an IRA, that is a differentiator as well. Another thing we wanted just to briefly explain was one other question that we sometimes get is “how much should I be contributing to my 401(k)?” or “how/what should I start it at?”. A good rule of thumb is if you are receiving a match, at least do what you can to contribute to get the full match because that’s free money.
If you think about it, that’s free money from your employer that is matching all those dollars, so at a minimum do that. If you’re not getting an employer match, we can help you back into what needs to be done, but another way to look at it is “do it until it hurts.” That’s the best way to start trying to save is if you can stretch yourself a little bit, it’s going to benefit you in the future. If you think about it, saving today is buying a day in the future that you are not having to work. So, if you want to see what that looks like to you, walk through your options of setting something up for yourself, we’d love to help you do that and you can always reach out to us here at Next Step, we’d love to help you on your journey! Y’all have a good one!