When it comes to saving for retirement, many automatically turn to the 401(k) or similar employer-sponsored plans. However, popularity doesn't always equate to the best choice for everyone.
While 401(k)s have their merits, there is another option out there which offers lower fees, an advantageous withdrawal structure, and superior flexibility -- the IRA. Although each investor's situation can vary, here's why it's my preferred choice for securing a comfortable retirement.
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Freedom to shape your portfolio
One crucial advantage of the IRA over the 401(k) is the level of freedom it provides because 401(k)s are often tethered to the investment options offered by your employer's plan. With IRAs, investors can choose from a vast array of stocks, bonds, mutual funds, and other investment vehicles. Consider a scenario where you have a specific investment strategy, such as focusing on growth stocks or diversifying through exchange-traded funds (ETFs). The IRA allows you to execute this strategy seamlessly, offering the autonomy to navigate the market in alignment with your own vision
That often means the ability to customize your portfolio based on risk tolerance, financial objectives, and investment preferences. This not only empowers you but also helps you to save money on the administration and service fees that are often present with 401(k)s. On average, 401(k) holders pay between 0.5% to 2% of their total portfolio in fees, which might not seem significant but can add up over time. On the other hand, with an IRA, you can eliminate most of these fees by investing in individual stocks or choosing ETFs and mutual funds that usually have expense ratios below 0.1%.
Withdrawal rules offer greater financial flexibility
Another compelling aspect of traditional IRAs lies in their more lenient withdrawal rules compared to 401(k)s. While both accounts allow penalty-free withdrawals after age 59½, traditional IRAs offer additional flexibility for specific life events.
First-time homebuyers, for instance, can withdraw up to $10,000 from an IRA without penalty to fund a home purchase. The flexibility extends to education expenses as well, allowing penalty-free withdrawals to cover qualified education costs. Additionally, if you find yourself unemployed and need to cover medical insurance premiums, a traditional IRA permits penalty-free withdrawals to ease the financial strain during such transitional periods.
Understanding the differences
While IRA's offer important advantages over 401(k)s, there are other considerations to be aware of before picking one over the other. An IRA is a personal account that you establish independently, but a 401(k) is employer-sponsored and usually comes with matching contributions. If your employer offers a match, you should contribute at least enough to capture the full matching amount since it's essentially free money going to your retirement savings.
Another key difference to note is that IRAs have a lower contribution limit compared to 401(k)s. In 2024, individuals under 50 can contribute up to $7,000 annually to an IRA, while those 50 and older can contribute up to $8,000. On the other hand, 401(k)s offer a significantly higher contribution limit, allowing individuals under 50 to contribute up to $23,000 and those 50 and older to contribute up to $30,500.
When planning for retirement, the choice between an IRA and 401(k) comes down to finding the best fit for your personal situation. Given the perks each account offers, don't hesitate to take advantage of both options. A savvy investor could first contribute to their 401(k) for the full employer match before transitioning to an IRA for the greater flexibility.
