Hello and welcome back to Part 2. We’re talking about the 5 reasons that an IRA might be a better retirement funding tool than your 401(k). If you haven’t seen Part 1 yet, we suggest that you go back and take a look at it after you’re done here. Enjoy.
With a 401(k) plan you’re limited to the mutual fund choices that your employer offers but with an IRA you suddenly have access to exchange traded funds (ETF’s) and stocks. “Investing in ETFs or individual securities through an IRA can have many benefits,” Kubik says.
ETFs typically charge lower expense costs than mutual funds and, if you trade frequently, the tax-deferred status of an IRA can help you keep your costs down. “It is easier to have a very tactical portfolio,” Kubik says. “An investor can buy and sell securities without the concern of tax consequences.”
While investing in ETFs if you have an IRA is a wise choice, Derek Tharp from Mold Wealth Management, a wealth managing company from Cedar Rapids, Iowa, says that, since stocks are a lot more difficult to manage, they likely won’t provide the kind of diversification a consumer needs to protect themself in the long run, and should be avoided. “The average investor should stay away from individual stocks,” he says.
While a 401(k) plan will allow you to delay paying your taxes while your money grows, the government actually still owns a portion of your investment until you finally pay those taxes. On the other hand, with a Roth IRA (which is different than a traditional IRA), you’ll actually pay your taxes up-front and then your money will grow tax-free. Even better, when you withdraw your money during retirement, you don’t pay taxes on it either.
“Tax deferral is a nice benefit, but it is nowhere near the benefit of tax-free growth,” Tharp says. Itzoe says a Roth makes the most sense for investors who expect their tax rate to be higher in retirement. However, it is hard to forecast that in advance. “I wish I had a crystal ball and could tell you what tax rates will be in the future,” he says.
If you withdraw your money from a traditional IRA or 401(k), you’ll pay taxes on it as well as a 10% penalty. There are exceptions to that rule however including the fact that a first-time homeowner can take up to $10,000 out of their IRA to apply it towards a down payment on a new house and they won’t pay a penalty on that money.
Also, if you take money out of your IRA to pay the college costs for a member of your immediate family, you won’t pay any penalties either. With the 401(k) however you’ll be staring down the barrel of that 10% early withdrawal fee.
Without a Roth IRA the limitations are even fewer as you can withdraw your contributions tax and penalty free whenever you like. You can also spend that money in whatever way you choose. One caveat is that this rule only applies to contributions, not investment earnings.
And there you have it, dear readers. 5 reasons why we believe an IRA, or a Roth IRA, is better than a 401(k) when it comes to saving money for retirement. Both have advantages of course but we believe that an IRA or Roth IRA have less disadvantages. Now that you know what those disadvantages are to having a 401(k), you can use your newly educated brain to make a smart financial decision based on your needs, financial situation and lifestyle.