Are you ready to start saving for retirement, but don’t know where to start?
You may be able to open an individual retirement account (IRA) or a 401(k)—or both—to begin your journey toward saving for a secure retirement.
Let’s explore the key differences between these two retirement savings tools so you can make an informed decision.
What’s an IRA?
An IRA, or individual retirement account, is a retirement savings account that’s set up at a financial institution like a bank, brokerage, federally insured credit union, or savings and loan association.
Many self-employed people who don’t have access to workplace retirement accounts utilize an IRA. However, anyone with earned income can open an IRA, even if they already have a retirement plan through work.
An IRA provides long-term, tax-advantaged savings to help people save for retirement. IRAs may provide the ability to invest in several financial products, including stocks, bonds, exchange-traded funds (EFTs) and mutual funds.
There are several different types of IRAs. Each has different rules when it comes to eligibility, taxation and withdrawals. Here are three main types:
- A traditional IRAis a tax-advantaged personal savings plan that may offer tax-deductible contributions.
- A Roth IRAis a tax-advantaged personal savings plan that may offer tax-free distributions (instead of contributions).
- A rollover IRA moves eligible assets from an employer-sponsored plan into a traditional IRA.
It’s possible to have multiple types of IRAs at different institutions, but the total annual contribution to all IRAs cannot exceed $7,000 (or $8,000 for those age 50 or older) for 2024.
Related: Bolster Retirement Savings After 50 With Catch-Up Contributions
Money held in an IRA usually can’t be withdrawn before age 59½ without incurring a hefty penalty of 10% of the amount withdrawn, in addition to taxes on the withdrawal. However, there are some exceptions to the penalty, such as medical expenses, disabilities or first-time home purchases.
In general, age 60 or older is the best time to withdraw from an IRA. Required minimum distributions (RMDs)—which are withdrawals that traditional IRA owners must make every year—begin at age 73.
What’s a 401(k)?
A 401(k) is a retirement savings tool that may be offered by employers.
There are two main types of 401(k)s, traditional and Roth. The main difference is that a traditional 401(k) is funded with pre-tax dollars, while a Roth 401(k) is funded with after-tax dollars.
The money in a 401(k) grows through employee contributions, which are usually a percentage of each paycheck paid directly into an investment account. In 2024, the annual limit on employee contributions is $23,000 for workers younger than 50. Workers over the age of 50 can contribute up to $30,500.
401(k) value may also grow through employer matching. With Roth 401(k)s, employer matching must be placed in a separate pre-tax 401(k).
401(k) savings also grow through investment earnings. Employees may have the option to choose among several investment options, usually an assortment of stock and bond mutual funds and target-date funds.
In general, employees can begin withdrawing from their 401(k)s at age 59½, or if they meet other criteria dictated by the IRS. With a traditional 401(k), withdrawals are taxed as ordinary income. With Roth, taxes have already been paid and no additional taxes are owed, if certain requirements are satisfied.
Related: Is a 401(k) Hardship Withdrawal Right for You?
We Can Help You Navigate Saving for Retirement
Let a Bankers Life Advisory Services, Inc. Financial Advisor help guide you through the challenges of investing. Our team can help you create a personalized solution built to provide long-term investment success! Learn more about us here.
Want more? Check out our blog, Traditional IRA vs. Roth IRA vs. 401(k): A Simple Rundown.
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