Here’s What Happens When You Save for Retirement in an IRA Instead of Your Company’s 401(k)

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IRAs have their benefits, but you might miss out if you don’t sign up for an employer-sponsored 401(k). Read on to see why. 

When it comes to saving for retirement, you have choices. If your company doesn’t offer a 401(k) plan, you could always open an IRA and save for retirement there. And even if you do have access to a 401(k) through your job, you should know that you’re not obligated to participate in it. You may prefer to open an IRA because it gives you more investment choices.

With a 401(k), you’re generally limited to a bunch of different funds to invest in, like target date funds, mutual funds, and index funds. But with an IRA, you’re generally allowed to invest in individual stocks for retirement. And that can be helpful in two ways.

First, when you hand-pick stocks for your retirement portfolio, you get complete control over what you own, whereas with a target date or mutual fund, you don’t. That could allow you to generate higher returns in your portfolio.

Also, many of the funds you’ll typically find in a 401(k) charge high fees. So you might lower your investment fees by opting for an IRA.

But when you save for retirement in an IRA instead of your company’s 401(k), you miss out on employer matching funds. And giving up that money is something you may not want to do.

Forgoing free money could hurt you

Many companies that sponsor 401(k) plans also match worker contributions to some degree. BetterUp reports that the average 401(k) match today is 4.7% — meaning, the typical employer will match 4.7% of a worker’s salary.

So, let’s say you earn $60,000 a year and your employer offers a 4.7% match. That means that if you contribute 4.7% of your salary, or $2,820 a year, to your 401(k), your employer will also give you $2,820. If you don’t save in your company’s 401(k), but rather, opt for an IRA instead, you’ll lose out on that match.

That’s a big deal, though, because the money you put into your 401(k) doesn’t just sit in cash. Rather, it gets invested.

So, let’s say you pass up $2,820 this year, but your 401(k) plan’s investments normally deliver a 10% average annual return, which is comparable to the stock market’s average return over the past 50 years. If you’re 30 years away from ending your career, passing up $2,820 really means denying yourself $49,200 in retirement income when you factor in lost investment growth.

You may want a 401(k) and IRA at the same time

You may be inclined to believe that you can’t save for retirement in an IRA and 401(k) at the same time, but that’s not true. And if you’d rather save in an IRA but your 401(k) is eligible for employer matching dollars, what it pays to do is fund your 401(k) to get your match in full, but then put the rest of your retirement savings into your IRA.

So as an example, let’s say you can afford to save $500 a month, or $6,000 this year, for retirement. If you’re entitled to a match worth $2,820 in your 401(k), contribute that sum alone to your employer’s plan. Then, put your remaining $3,180 into your IRA. It’s that simple. And that way, you get the best of both worlds — free money for your retirement as well as the opportunity to invest your money however you want.

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The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.Maurie Backman has positions in Target. The Motley Fool has positions in and recommends Target. The Motley Fool has a disclosure policy.

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