IRAs vs. 401ks

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*sigh*

All this SS talk has got me thinking about how I'm planning for my own retirement. Currently, I invest in a 401k plan, but I don't have an IRA. Someone recently suggested to me to consider getting an IRA, and I actually am considering it. I always considered IRAs were for people who were considerably older than me, who hadn't put enough away earlier in their lives and were attempting to "catch up" by investing more now. I have to assume that this analysis is flawed in some way.

So what do other people do? If I'm investing a good chunk of my income into a 401k do I really need an IRA? Do I want an IRA? Is an IRA really a good long term alternative to a 401k, or is it merely a solid addition to a 401k? Any suggestions here would be great.

 

I don't know much about this kind of stuff, but I'd guess the answer is probably - it depends.

Is your 401k matching? How much do you make and how much do you have to invest? How much money do you make now? How much money do you anticipate having in the future? Will you ever need to access your funds for purposes other than retirement?(med bills, house, etc.)

If you aren't making too much money, and an IRA would be right for you, you may consider a Roth IRA vs. a traiditional IRA (can you do both? I don't think so but may be wrong.) I read recently (USA Today a few days ago actually) that a max contribution to a RothIRA from now if you're 30 until age...65 I think, and assuming an average of something like 7 or 8% ends up with something like 970,000 when you take it out. Given that with a RothIRA you would be able to withdraw that money tax free, yeah, it could be worth it. If you need it, etc.

I believe with a traditional IRA, you reduce your taxes now but pay taxes on the full amount when you take it out. With a Roth, I believe you don't get to take a deduction now but when you take the money out you don't pay any taxes on any of the money, including the earned interest which may be significant.

I'm not aware of any drawbacks to having an IRA in addition to a 401k, but I certainly could be missing something.

 

Having not kept up with recent tax code, I am not certain of the limits on placing money in both an IRA and a 401k. Additionally, the Roth IRA and Educational IRA add complexity to this equation.

For young people, if you can afford it, you are usually better served by putting enough in your 401k to maximize your employer matching (if your employer doesn't match, their 401k is probably not your best bet) and then place the rest of what you can afford in a Roth IRA. You have to look at the impact of paying your taxes now, and avoiding having to pay them (on the amount placed in the Roth and the returns!) when you retire as you can in a Roth. The advantage to a 401k is that you defer payment of taxes until you are more likely in a lower tax bracket, as most people retire to a lower income than they currently make.. However younger you are, the more a Roth pays off, as you earn tax free returns, and often young people have lots of write offs, such as children and a heavy mortgage with lots of interest, so their tax burden may not be that high anyway. Even if you rent and have no children, you should look at your capacity to support your tax burden today, rather than putting it off to retirement, when you may not have the ability to support it.

The difficult part of a Roth for young people is that they usually aren't willing to forego the current tax write-off for a benefit that is decades down the road.

I would suggest googling Roth IRA, you will find lots of good info from reputable sites.

 

Why are financial matters SO complicated in the USA? I thought I was quite au fait with financial jargon but it's like you guys are talking a foreign language. No wonder you have to pay someone to do your tax returns.

 

Hell, Aldeth, I just turned 25 and I'm already thinking about how to invest for my retirement... although thankfully it's not that complicated in Australia.

 

I guess I need to give some background information here so people can more fully answer my question. First the basics - I'm nearly 31, married, with no children (at least not yet). The 401k plan I have at work the company matches up to 5% of your annual income, and matches nothing after 5%. So for me, I contribute 5% of my annual earnings into the 401k so that I get the maximum employer contribution. My company would allow me to invest more than 5% of my income into the 401k, they just don't match beyond 5%. So in essense, I'm contributing 10% of my annual income in the 401k (5% from me, 5% from my company).

On the other hand, I am contributing absolutely nothing into any type of IRA. However, as BTA says, I'm limited to $3000 annually, which seems like not very much at all. Granted with interest every year, that can turn out to be a lot when I retire 35 years from now. Still, with a $3000 annual maximum, it seems like I will always be contributing significantly more to my 401k than to my IRA.

 

Thanks for starting this thread, Aldeth. Lots of good stuff to chew on here.

I myself had my 401k maxed out at my job when I was full time (in school again, so I'm back down to part time) and yes, my employer did match it. They were actually surprised that I wanted to invest in a 401k at all - let alone max it out - given my age (23 then, 25 now). Evidently, people in their twenties even thinking about retirement savings are a rarity here in the states. Not that I'm surprised, really - but it is interesting.

Once I graduate, finding an employer who matches the 401k is definitely a priority for me. I'll be getting an IRA as well. I don't know much about mutual funds, but after the big scandal that happened last year, I'm not too sure I want to even go there.

Then again - perhaps now firms that manage mutual funds are taking extra care to be on the up-and-up because of those scandals, so as not to scare off guys like me. Know anything about them, BTA?

 

I'm still not really clear on what either a 401k or an IRA is. Why don't you guys give them simpler names? Like "Pension" or something, so we can understand.

In New Zealand, life is much less complicated. You save for your own retirement. If you end up retiring really poor, the government will give you enough so you don't starve. Otherwise you live off whatever you have saved. You can save however you want (cash, buying rental properties, shares, unit trusts, life insurance, pension plans, etc) but the principles are more or less the same. No funny acronyms or numbers here.

 

Because we're America, dammit. Simple is for wussies.



Thanks BTA - good stuff to chew on. By the way - when did you start investing? How old were you? (you don't have to aswer if you'd like to keep your age top secret or something).

 

Man. There's more than one type of "IRA"? So let me get this straight. In order to simply save for your retirement, you have to save money in four places:
1) A 401 grand;
2) a Tim Roth IRA;
3) a personal brokerage account; and
4) a traditional IRA.

Anyway, what I do understand is that you have been taking personal responsibility for your retirement savings since a reasonably young age. That should be applauded strongly as it is all to rare in today's consumer-driven, debt complacent western society.

All the youngsters on SP should take note and follow Blackthorne TA's example.

 

When I saw the title of this thread I thought it was about the Irish Republican Army. Or, 'scum', as they are better known.

Having read it, I'm not actually sure what it's about.

Meh, don't tax my brain like this on a hungover morning please.

 

Some quick definitions.

401K- This is a payroll deduction. You select how much you want to contribute and your employer contracts with an investment house to give you choices on how to invest the money. The money that you contribute is excluded from your taxable income. Most companies usually offer some sort of a match to the money you put in. Upon retirement as you take the money out it is taxable income to you (both the principal and interest)

IRA- Individual Retirement Account- Has nothing to do with the employer. However, you have to have earned income (wages) as opposed to unearned income (investment) to contribute to one. The money you put in may or may not be a reduction of your taxable income when you file your annual tax return. It all depends on your situation. When you retire the interest is always taxable and the principal may be taxable depending on if you got a reduction of your taxable income when you contributed the money.

Roth IRA- Similar to an IRA, with some key differences. Contributions are never a reduction of your taxes, but upon retirement both the principal and interest are tax free.

The advice I give people is to always max your 401K to get the maximum employer match. Then you should max out your contributions to a Roth Ira. If you still have additional funds that you want to contribute you should increase the 401K.

 

As Snook points out, the big reason people are encouraged to start investing as early as possible are two fold. First, the longer you invest for, the more interest you will earn over the life of that investment. Someone who starts a 401k or a Traditional IRA at age 25 will likely have more money saved for retirement than someone who starts at 35, even if the 35 year old puts more in the 401k every year.

The second factor is a tax break. Any money you place into a 401k or IRA is considered "pre-tax" meaning it's like you never earned that money when calculating your taxes at the end of the year. For example, if you earn $50,000 in a year, and contribute $5,000 of that money into a 401k plan, you are only taxed as if you earned $45,000.

 

Huge problem in USA, UK, and NZ is the lack of personal savings of any form. Anything to encourage more savings should be applauded. Far too many people have large credit card balances instead of large retirement nest eggs.