Should You Have a 401K, an IRA Or Both?


One of the most important aspects of overall financial health is to save and prepare financially for retirement. Not saving enough for retirement could be financially devastating as this could force you to work well past a typical retirement age or cause you to run out of money years prior to your death. While saving for retirement can be tricky, 401k and IRA accounts come with tax advantages that make saving easier. When deciding whether or not to invest in a 401k, IRA, or both, there are several considerations to make.

The first consideration to make when deciding to invest in a 401k or IRA is whether or not you have an employer sponsored 401k with contribution matching. To encourage employees to save for retirement, many employers offer 401k plans that come with contribution matches of up to 5% of the employee’s salary. If your employer offers a match on the 401k, which is essentially free money to you, your first priority in retirement saving should be to contribute into the 401k until you have qualified for the full company match.

The second consideration to make is your future tax liability. The main difference between a 401k and an IRA is that a 401k is funded with pre-tax dollars and an IRA is funded with post-tax dollars. While contributions made into a 401k are made pre-tax, the eventual withdrawals will be taxed at your highest personal taxable level. Withdrawals from an IRA, on the other hand, will not be taxed in the future. Therefore, you need to carefully consider whether or not you think your tax liability will increase in the future, remain the same, or decrease. While most people’s income will decrease in the future, they must also consider the fact that the country is in debt and income tax hikes are inevitable. Because of the uncertainty of your future tax liability, it would be a good idea to diversify and invest a portion of your savings in both.

The third consideration to make when deciding between and 401k and IRA is how much control you want over your investments. 401ks, which are all employer sponsored, come with a very limited amount of investment choices. Depending on whom your employer chooses to service your account, your investment choices may be limited to just a few mutual funds. With an IRA, you will have far more investment choices. IRA investors could choose between individual securities, mutual funds, bonds, and a wide variety of other investment options. While having more choices may seem like an advantage, IRA investors may not have the same affordable access to the well-managed investment funds that 401k investors do. Because of this, many people would once again benefit by investing a portion of their retirement savings in a 401k account and a portion in an IRA account.

Regardless of whether you choose to invest in a 401k or in an IRA, the most important aspect of preparing for retirement is to save enough and manage your money. Most people should try to save between 10% and 15% of their gross pay each year. Once the money is deposited, it is important to keep a well balanced portfolio with investments in several different funds and securities. Furthermore, as you age and approach retirement, you should constantly re-strategize your investment plan and begin allocation more of your money from high risk investments into more stable investments.

This post was written by

jason – who has written posts on Budget Clowns.
Father of three and married to a lovely women. Always looking for ways to save money, and invest it properly for my children's future.

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