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IRA vs. 401(k): Which is Better?

IRA vs. 401(k): Which is Better?

There are many retirement accounts, but two are familiar – the Roth IRA and the 401(k). The two have a big difference: you can get a 401(k) account from your workplace while you can open and fund a Roth IRA account. If you're still deciding which account to use, this article will clear the fog and help you make up your mind. 

What is an IRA?

As earlier stated, an individual or a spouse can open an IRA account if they can fund it for retirement, which attracts many tax benefits. The money in the account is tax-free or tax-deferred until retirement or when the fund is moved. In addition, the account attracts large interest helping your money grow and accumulate over time. As of 2022, the IRS set the standard donation at $6,000, though the changes happen every few tax seasons. However, those over 50 years are given the privilege of having a $1,000 extra contribution yearly. 

You can get an IRA account from different financial institutions, such as banks and brokers. In addition, you can get other assets like CDs, bonds, stocks, ETFs, mutual funds, and more through the IRA account. Another edge it has over other accounts is that it allows owners to invest in high-profiting assets.                          

Types of IRAs

The IRA accounts are of two types with different tax advantages.

  • The traditional IRA attracts a pre-tax, which exempts you from paying taxes on your contributions. The account grows your money tax-free till your retirement at 59½ or later when you transfer the money. However, you have a minimum withdrawal limit that binds you.

  • The Roth IRA doesn't offer a tax break on contributions but offers tax-free interest. In addition, you'll withdraw your money after retirement tax-free, and the law of minimum withdrawal does not apply in this case. And you can give the money as an inheritance, also tax-free.

What is a 401(k)?

The 401(k) plan is an individual's retirement account from the workplace. The account allows taxpayers to save and grow their contributions tax-deferred or tax-free. However, the money is taxable at withdrawal after retirement. In addition, the plan allows employees to invest some money in assets like stock mutual funds. A taxpayer can contribute up to $20,500 to the account in 2022. However, employees who have clocked 50 or more can contribute an extra $6,500 annually. The account is your employer's responsibility, but the contribution comes from you and the employer. In addition, the account may award you 3 to 5% of your salary.   

Types of 401(k) plans

  • The traditional 401(k) does not attract tax on contributions, and interest is tax-free until withdrawn at age 59½ and above.

  • The Roth 401(k) attracts tax on contributions, but the interest is tax-free and is withdrawn at retirement. However, the account is subject to minimum withdrawal from age 72.

Is it better to have a 401(k) or an IRA?

Finally, choosing between IRA and 401(k) depends on personal situations. The 401(k) is for people with an employer who enjoys a low-fee plan and expect a lower income tax rate than the present tax rate. However, ensure you are paying only a few fees by reviewing your 401(k) investment option. Also, you need to be investing in the right fund.

However, if you are saving on a tax-free basis, you need an IRA account. However, both have different tax treatments for withdrawal. The IRA account is tax-free, allowing the government to receive fewer fees. 

In essence, the benefits and drawbacks of both accounts are different, but each account can be handy after retirement. The best way to go about this choice is to hire a tax professional to run the numbers. It may come at a cost but is insignificant to the result or benefit.



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