By Judy Loy, RICP®, ChFC® and CEO of Nestlerode & Loy, Inc.
401k plans are synonymous with employer retirement plans. While many types of employer plans exist (Simple IRA, Sep IRA and 403b), most employees call their retirement plan a 401k. Many people wonder if they should contribute to their 401k or an IRA. An IRA is an account setup by an individual with no employer involvement.
The first thing to consider is whether your employer plan offers a match. Many employer plans offer a percentage match to employees who contribute. For instance, to avoid some testing many employers opt for a safe harbor match, which consists of a 100% match on the first 3% and 50% on the next 2%. This means if you put 5% in you get 4% tax free from your employer inside your 401k. The bottom line is if your 401k has a match, take advantage of it! This is free money and part of the benefits you earn from your employer.
If your 401k plan does not have a match, there are other things to consider when deciding to contribute to your company’s plan. 401k fees fall into two categories: investment fees and administrative fees. Fees are required to be disclosed and if you want to know how much you pay, request a 408(b)(2) disclosure from your employer. Investment fees are associated with managing plan investments and the investments themselves. Administrative fees are expenses for basic services-plan record keeping, accounting, legal and trustee services. Some employers pay these fees. While 401k plan fees are only one consideration when deciding on your 401k, it is important to be informed.
IRA accounts typically have two types of fees: investment fees and annual fees. Annual fees apply to IRA accounts because the custodian must do the appropriate tax reporting and typically range from $10-$50. Underlying investment fees depend upon the investments chosen and the advisor oversight.
Investment options are important. Most employer plans are limited to a set of mutual funds inside the 401k with the average having 25 investment choices. To decide if your available 401k has good options, check on the underlying investment expenses and the returns on the funds available.
IRA accounts are typically open to many investment choices, individual stocks, ETFs, mutual funds and annuities. In other words, an IRA typically has more investment options. This may be better or worse for the investor as more choices may lead to more confusion. Other investors may prefer being able to use any mutual fund or invest in individual companies.
The main difference between a 401k and an IRA is the contribution eligibility. In 2019, a 401k plan permits the employee to put as much as $19,000 into their 401k for the year and an additional $6,000 if they are over 50 years of age. If you have a retirement plan at work, the eligible employee can contribute to an IRA only if their income level is below $122,000 (filing single) or $193,000 (married filing jointly). If modified adjusted gross income (MAGI) is below this level, an employee may contribute $6,000 to a traditional IRA and an additional $1,000 if they are over age 50. If an employee does not have a retirement plan at work, typically they can contribute to an IRA.
Trying to decide between a 401k or IRA is a very personal choice. The most important thing is that you make contributions to retirement. If permitting an employer to deduct money from your paycheck is easier, then definitely set a 401k contribution up. A good idea is to set it as a percentage. That way as you get raises, so does your retirement. If you don’t have a retirement plan through work, put money into an IRA or Roth. You can have a set amount go in automatically from your bank every month. Saving just a little bit each month makes a world of difference for your retirement.