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Questions To Ask Before Opening An IRA Or 401 (k)

Questions to Ask Before Opening an IRA or 401 (k)


Getting started with saving for retirement involves many options: how much can you afford to stash, what to invest in, and – maybe before you get to all of that – what type of account you should open.

There are IRAs, individual pension schemes that you open yourself. And there are 401 (k) s, plans that you can access through your employer.

Both are great vehicles for building a nest egg for retirement, but there are some key differences between them.

We explain the nuances of an IRA versus a 401 (k) to help you decide what type of account to open.

Answer: Ideally both.

What is a 401 (k)?

A 401 (k) is an employer-sponsored retirement plan where contributions are typically deducted from your pre-tax paycheck.

The money in your 401 (k) grows over time by investing in mutual funds, stocks, and bonds. With a few exceptions, you cannot withdraw funds from your 401 (k) until you are 59 ½ years old without a 10% penalty.

Because your premiums are pre-taxed, you will have to pay income tax when you withdraw your funds in retirement.

You need to make 70½ withdrawals first. Then you need to make what are known as the minimum required distributions.

You can contribute up to $ 19,000 per year to a 401 (k) (plus $ 6,000 more if you are over 50). There are no income restrictions and your contributions are not considered taxable income.

When should you invest in a 401 (k)?

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A 401 (k) may be a good retirement plan if you answer yes to any of the following questions:

Does your employer offer a 401 (k) and does it match your posts?

In that case, this benefit can maximize your retirement savings. You use your own money, usually up to 3% of your salary. And everything that your employer brings together – i.e. H. Also adding to your account – is basically free money.

Does automatic salary deduction suit your savings style?

Payroll deductions are seamless and hassle-free. You never see the money and you will not be tempted to spend it.

Could You Use The Lower Income Tax?

If you are currently in a higher tax bracket, your 401 (k) pre-tax contributions can now reduce your taxable income. And if you expect to live less on it when you retire, you might fall into a lower tax bracket when you’re ready to make withdrawals. These tax savings can really add up.

Have you reached the maximum annual contribution of your IRA?

If you’ve reached the maximum annual contribution for a Traditional or Roth IRA, you can still contribute to a 401 (k). The annual contribution limit of $ 19,000 enables mega-savings.

What is an IRA?

An IRA is an individual retirement account that is not assigned to an employer. It stays with you regardless of where you live and work or your marital status.

You open an IRA yourself and can invest up to $ 6,000 per year – or $ 7,000 if you’re 50 or older – on top of 401 (k) contributions.

You contribute when it suits you and choose which mutual funds, stocks and / or bonds to invest your money in.

Most IRAs do not have a minimum deposit requirement, but some investments may have purchase requirements and a mandatory annual subscription.

Your contributions to a traditional IRA may be fully tax deductible depending on your financial situation, but your withdrawals will be taxed as income. With a few exceptions, you can withdraw money from your IRA as soon as you are 59 ½ years old without the 10% early withdrawal penalty. You must also make a minimum annual withdrawal once you are 70 ½ years old.

What about a Roth IRA?

Traditional and Roth IRAs are similar, but there are some key differences.

The biggest difference: your contributions to a Roth IRA are made with after-tax funds, which means the withdrawals in the backend are tax-free. Woo!

Roth IRAs have income limits. Individuals earning more than $ 137,000 per year or married couples earning more than $ 203,000 per year cannot contribute.

As with a traditional IRA, the maximum annual dues for a Roth IRA are capped at $ 6,000 – or $ 7,000 if you’re 50 or older.

You can withdraw the money you contribute before the age of 59 without penalty as you have already paid tax on it. However, if you withdraw this before the age of 59, you will receive a 10% penalty on the income. You can skip the early withdrawal penalty if it’s college, medical bills, or first-time home purchases.

Unlike a traditional IRA, a Roth IRA does not have a mandatory distribution requirement so you are not forced to withdraw at 70½.

As with a traditional IRA, with a Roth IRA you have to invest yourself.

When should you invest in an IRA or a Roth IRA?

A woman ponders a decision while looking at a computer laptop on a patio.
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Opening a traditional IRA or Roth IRA can be a good option if your situation meets some of the following criteria:

Your employer doesn’t offer a 401 (k) match or other retirement plans.

IRAs are great home improvement savings options as they are not tied to an employer. An IRA gives you the freedom to invest in it Your Conditions regardless of your situation, especially if you don’t have access to a 401 (k).

You are a job hopper or you don’t plan to stay with your current employer for long.

Switching jobs is becoming increasingly common and with that comes the pain of constantly rolling over your old 401 (k). An IRA stays in one place while you take advantage of all of the vacancies.

You prefer to decide how and where your money will be invested.

With IRAs, you have complete control over the type, quality and amount of investments. You can manage it yourself, while in a 401 (k) you pay to have someone else manage it for you. It’s like making your own dinner at home or eating out. Essentially, an IRA is like selecting the ingredients and putting the oven on “bake”.

You are in a low tax bracket.

If you’re young and have a low tax bracket, consider a Roth IRA. Seriously, you pay the lowest possible taxes now and reap the rewards later.

If you plan to move into a higher income bracket in retirement or if you don’t want to bet on future tax rates.

Paying taxes on Roth IRA investments upfront is ideal if you are studying for a high income profession or climbing the corporate ladder. The more you earn, the more tax you will pay in the long run. There is also the risk of retiring later – who knows how high the tax brackets could be in 30 to 50 years.

You have reached the maximum annual contribution limit for your 401 (k).

If you’ve hit the $ 19,000 limit on your 401 (k), this is good for you first of all! Second, you can still invest up to the maximum amount in an IRA.

You want to make a contribution for the past year.

You can contribute to your IRA for the previous year up to the tax return deadline of the current year.

IRA vs. 401 (k): Final thoughts

Whichever option you choose, don’t forget to check the fees and make comparative purchases. It’s a competitive market and some plans include value-added services, resource tools, and automatic withdrawals.

“There is no set and forget it,” said Catherine Collinson, CEO and President of the Transamerica Institute. “Nobody is more interested in the results of your retirement provision than you and your family.”

One way or another, you’ll be so lucky to have a stash of cash in the future. Even if you can only donate $ 100 per month, the interest on that money will increase over time, helping you when you need it most.

“The most important thing is to save for retirement and to save consistently,” said Collinson.

Stephanie Bolling is a former employee at The Penny Hoarder.


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