Every year, millions of taxpayers wonder whether it’s best to put their retirement money into a 401k plan or an IRA. Of course, the ones who have to make the decision are the lucky few who have access to an employer-sponsored 401k; you can’t start a 401k on your own. Still, it’s not always clear what the best strategy is. Should you max out the 401k and ignore IRAs altogether? Or is it smartest to only use IRAs, either a Roth or a traditional version, and forego the 401k?
Here’s a look at what the overall strategy should be for those who have the option of a 401k, along with a list of pros, cons and contribution limits for each type of retirement plan.
There are two basic kinds of 401k plans: employer-matched and non-employer-matched. As for IRA, there are also two kinds: traditional and Roth. If your employer doesn’t offer a 401k, then the decision is pretty much made for you. You only need to decide whether to go with the Roth or traditional. See the section below on pros and cons of those to decide what to do if that’s the only decision you need to make.
But if your employer does offer a 401k, your options become more numerous. Here’s the standard strategy that will boost up your net worth like Steph Curry, and give you the most leverage when it comes time to take the money out: With a matching 401k, always max out the matched contribution first. If you can’t afford to go that high, it’s okay but don’t even think about an IRA. If you can contribute up to the match maximum, switch over at that point and contribute to an IRA as well. If the 401k offers no match, contribute the maximum amount to an IRA first, then put whatever else you can afford into the 401k.
Roth and Traditional IRAs
Contribution limits are $7,000 for people 50 or older, but only $6,000 if you’re 49 or younger. The pros include a wide range of investments to choose from, deductible contributions with a traditional and no required distributions for Roth’s.
The key determinant for your contribution limit on a 401k is your age. If you are older than 49, you can contribute $25,000, but if you are 49 or younger, the limit is $19,000. The big advantages of 401k plans include the option for taxpayers to get an employer match, a very high yearly limit for contributions, tax deductions for amounts contributed, and the fact that no matter how high your income is you can still contribute to the plan.
On the negative side, you’ll still need to take mandatory distributions by age 70.5, will have to pay tax on those distributions, have a limited choice of investments within the 401k, and have virtually zero control over costs of the plan and how the money is invested. The employer runs the show and you’re just along for the ride, so to speak. On balance, 401k plans are usually a much better choice for taxpayers than the traditional or Roth IRA option.