I Lean Towards Choosing a 401(k) Over an IRA for Retirement Fund Accumulation: My Reasons Explained
I Lean Towards Choosing a 401(k) Over an IRA for Retirement Fund Accumulation: My Reasons Explained
When it comes to retirement savings, there's a plethora of options. However, the 401(k) plan and the Individual Retirement Account (IRA) are the two most popular choices. Both are reliable options, and they share some similarities in how they function and the guidelines investors must adhere to.
However, there are notable variations between a 401(k) and a traditional IRA. Three of these differences make the 401(k) the preferable choice (in my humble opinion) for many individuals.
1. Greater contribution limits
Your financial success depends on three factors: how much you invest, how rapidly it grows, and the length of time you let your portfolio's growth compound.
Whenever you contribute to a 401(k) or IRA, the income tax you would owe on that money is delayed until you withdraw it during retirement. The IRS imposes an annual limit on how much you can contribute to these plans, thereby enabling individuals to lower their taxable income by a certain amount in a given year.
One of the most significant advantages of a 401(k) plan over an IRA is the higher contribution limit.
In 2024, individuals can contribute up to $23,000 to their 401(k), which will rise to $23,500 in 2025. In contrast, for IRAs, individuals can only contribute up to $7,000, with no increase expected in 2025.
However, the gaps are more substantial than they may appear. Many employer 401(k) plans offer a 401(k) match to encourage workers to save for retirement. The IRS allows plenty of wiggle room for these additional funds. The total contribution limit for individuals in 2024 is a remarkable $69,000.
But there's more -- and older workers will appreciate this. Once you turn 50, you're allowed to contribute an additional $7,500, and starting in 2025, this "catch-up" increases to $11,250 for those aged 60, 61, 62, and 63. Meanwhile, the IRA allows an additional $1,000 in annual contributions for those 50 or older.
2. Employer match
As mentioned earlier, many employers provide a match for some of your contributions to their 401(k) plans to encourage people to save for retirement. For every dollar you set aside, they contribute either a dollar-for-dollar basis or a specified fraction, up to a certain fraction of your salary or a predetermined cap. A typical match is dollar-for-dollar up to 3%. So, if you make $100,000 and put 3% of your salary into your 401(k), your annual contributions will total $6,000 -- $3,000 from you and $3,000 from your employer.
This money typically comes with no conditions other than a vesting period to discourage employees from leaving the company. An employer match is an easy way to boost your total savings, and as a perk, it's peculiar to 401(k) plans.
3. Simplicity
A common argument in favor of IRAs is their flexibility. With an IRA, you have a variety of investment options, including individual stocks. By contrast, the investment options in most 401(k) plans are often limited to mutual funds. Some have started offering exchange-traded funds (ETFs), but you generally can't purchase individual stocks in a 401(k). (The exception is your employer's stock; many companies make their matches in their own shares.)
However, I believe this is a strength, not a weakness. Owning individual stocks is not inherently problematic, but even the best tools can harm you if misused. Building and maintaining a portfolio of individual stocks requires a significant amount of time and effort. You should strive to stay informed about the companies you own, and it's wise to diversify your portfolio to reduce your risk. It's less work when you own mutual funds and ETFs, and they have diversification built into their structures. The simplicity of 401(k) plans serves as a guardrail that can help prevent investors from going off track with their investments.
In regards to retirement savings and money management, the higher contribution limits of a 401(k) plan make it a more attractive option for many individuals, allowing them to save a significant amount before reaching retirement age. Additionally, some employers offer a match for 401(k) contributions, providing an extra financial boost that is not typically available with Individual Retirement Accounts (IRAs).