Are 401(k)s Better Than IRAs? It’s Debatable

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Both plans have their benefits as well as drawbacks. 

No matter your age, it’s a good idea to start diverting some of your income to a retirement savings plan. You’ll need personal savings to tap later in life, and the sooner you start building a nest egg, the more wealth you might grow.

When it comes to saving for retirement, you have choices. You could keep your money in a regular brokerage account, but then you won’t reap any tax breaks in the course of saving for the future. And so a better bet may be to choose between an IRA account and a 401(k) plan, assuming you have access to both.

Now you’ll often hear that 401(k) plans are better than IRAs. But that’s not necessarily the case. So if you don’t have access to a 401(k), don’t sweat it. And even if you do have access to a 401(k) plan through work, you may want to opt for an IRA instead.

The upside of 401(k) plans

The IRS sets a limit each year on how much money you can contribute to different retirement savings plans. This year, savers under 50 can contribute up to $22,500 to a 401(k), whereas IRAs max out at $6,500. Meanwhile, savers 50 and over can put up to $30,000 into a 401(k), and only a maximum of $7,500 into an IRA.

If you’re someone who wants and is able to pump a lot of cash into a retirement savings plan, then you may find an IRA too limiting given its lower contribution limits. That said, for many people, putting even $6,500 or $7,500 into a retirement plan is a stretch, so if that’s the boat you’re in, then the fact that 401(k)s come with higher contribution limits may not matter to you.

But there’s another key benefit of being able to save in a 401(k) — free money. Many companies that sponsor 401(k) plans also match worker contributions to some degree. Your employer might, for example, match 100% of up to $3,000 in contributions. This means that if you put $3,000 of your own money into a 401(k), you might get an additional $3,000 from your employer. With IRAs, there are no matches to be enjoyed.

The upside of IRAs

Although you can’t contribute as much to an IRA as a 401(k), and you won’t get free money in your account, IRAs tend to come with lower fees than 401(k)s. And remember, high fees can eat away at your returns over time, costing you money.

Also, 401(k) plans generally do not let you invest in individual stocks, and they tend to limit you to a relatively small group of funds to choose from, some of which might come with hefty investment fees known as expense ratios. IRAs, on the other hand, tend to offer far more investment choices. You can buy individual stocks in an IRA, or load up on ETFs if you so choose. That could help not only keep your fees down, but also, help ensure that your portfolio lends nicely to your long-term goals.

Which account should you choose?

Clearly, there are pros and cons to both IRAs and 401(k)s. The good news, though, is that you actually don’t have to choose one over the other if you have access to both.

In fact, let’s say you’re able to save $5,000 this year for retirement, and your employer is willing to match up to $3,000 in 401(k) contributions. A good bet could be to put $3,000 into your 401(k), and then put the remaining $2,000 into an IRA.

With the $3,000 in your 401(k), you can benefit from an additional $3,000 you don’t have to work for. And you can invest the $2,000 in your IRA in just about any asset you feel is a good option for you.

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