Most people find the numerous choices offered when it comes to planning for retirement to be confusing. If you consider yourself to be among this group this post is an attempt at explaining the differences between a 401(k) plan and an Individual Retirement Account (IRA). There will be several terms you will come across throughout your study of finances that may be somewhat confusing until you get the terminology down. The path to financial security does not have to be as complex as we have a tendency to make it.
I would like to take this opportunity to encourage you to seek the guidance of a professional financial advisor. The resources and understanding that a competent financial advisor can share with you will be invaluable when the time comes to make the decisions that will have an effect on how your retirement savings are put into action for your retirement. We go to a mechanic for mechanical tips (at least I do) so it only makes sense that we would meet with a professional who has been educated and experience in economic matters for financial guidance.
When it comes to planning for your retirement, understand that both IRAs and 401(k) plans have strengths and weaknesses. There are also limitations as to how beneficial they can be when used in combination with one another as well as their own personal limitations. Each benefit that assists you in taxation and retirement must be regarded as carefully.
To begin, I want to share with you the concept behind a 401(k) plan. This is a program that offers a couple of benefits that have been much more desirable over other retirement plans. The first point to consider are the contribution limits allowed for a 401(k) plan. You can contribute up to 15% of your salary or a maximum of $17,500 per year (as of 2014). Of course, that is assuming that your employer doesn’t have limits on how much you can invest. The funds invested in your 401(k) account are pre-tax funds so it lowers the amount of taxes you are paying out of each paycheck. Many people also find that because the income is taken from their checks before they receive it it is far less painful to part with. As a person who has closely watched taxes, FICA, and Fido claim my earnings for years I can say that it is actually no less painful for me but some find it comforting and that is a genuine advantage. Finally, and possibly the most critical aspect to understand is that many employers will match a percentage of your contribution up to a certain amount each paycheck. As an employee, this increase to your investment is something employees consider when accepting an offer of employment from a company. I hope you appreciate the advantages a 401(k) plan can have on your future earnings. However, keep in mind that the penalties for accessing these funds early are severe in order to discourage the practice from happening. Many people only access their investment funds early in extreme cases such as medical emergencies.
Individual Retirement Accounts are a very different financial asset all together. You will find much stricter limitations on IRAs than on 401(k) plans starting with if your employer provides a 401(k) you must earn a much smaller income in order to qualify for the tax deductions that this retirement fund typically allows. The maximum yearly contribution for an IRA will be $5,500 or one hundred percent of your annual earnings, whichever is greater, up until the age of 49. Once an investor reaches the age of 50 they can invest an additional $1,000 into your fund. Another significant disadvantage with an IRA is the fact that you must begin receiving payments at the age of 70.5 from your account. An IRA is also severely penalized for early withdrawals.
Whether you decide on a 401(k) plan, an Individual Retirement Account (IRA), or both for your retirement plan, it is important that you take some time to discuss the advantages and disadvantages of each plan with your financial advisor before making your ultimate decision about which plan is right for you.