I frequently field questions from people asking me to compare the use of a 401(k) account to an IRA, and I’ll discuss this a bit today.
401(k)
- No income limits to make deposits
- Company may offer matching up to some level
- (Usually) limited choice of investments
- Fees may be excessive
- $15,500 deposit limit ($20,500 if 50 in 2008)
- Loans permitted at reasonable rates
Traditional IRA
- Income restrictions (single $53K-63K, joint $83K-$103K)
- No company match
- Unlimited investment choices, mostly
- Fees can be controlled, kept to a minimum
- $5000 deposit limit ($6,000 if 50 in 2008)
For those whose company matches some of their 401(k) deposit, I suggest depositing up to the match. Often, this means that for the first 5-6% of your income, you are matched 50-100%. This is worth doing almost without regard to the rest of your financial situation. Next, unless the 401(k) has truly superior choices (my company offers an S&P index fund for .05% per year. On $100,000, this is a $50/year overhead) I’d suggest going to the IRA and topping it off. As I published some time ago in my 401(k) Ripoff article, some 401(k0 custodians are charging as much as 1.4%/yr for the accounts of small employers. This expense negates much of the benefit of saving tax deferred. Unless you plan to leave an employer with such a high expense 401(k) after a brief time, I’d not deposit more than what it takes to capture the match.
One lesser known benefit of a 401(k) is that if you retire and are 55 or older on your retirement, you may take withdrawal from the account without penalty. This suggests that as you approach retirement, you might decide to pull your IRA money into that final 401(k) account to take advantage of this. Of course it depends on the balances of your various retirement accounts.
After 59-1/2, I favor moving the 401(k) accounts into an IRA as the management becomes easier. Withdrawals may be done on line, the funds moved from the IRA to your cash account, and you can write a check the same day. The choice to convert to Roth is easier, done quickly and with minimal effort. Lastly, I suggest you pay close attention to the beneficiaries on your retirement accounts. It’s too easy to forget that a first spouse is still listed, or that the current beneficiary may have predeceased you. The rules regarding IRA beneficiaries are pretty specific, and must be listed on the account. IRAs do not pass via will. Please read my April 28 post “On my Death, Please Take a Breath“. It’s a sad anecdote about what not to do when inheriting an IRA or other pre-tax retirement account.
As always, please submit a comment if you have any questions on this topic.
Joe
Hi Joe,
I just found your sight and it’s great!!
My wife and I are trying to make the right choices for retirement but with so many options and blessings we have, it’s got our heads spinning. We are both 50 yr.old empty nesters, each covered by a defined pension, each with traditional IRAs that we cannot contribute to anymore, each with Roth IRAs which we have contributed to the max, the wife has a 403b and I have a 401k.
We have funded my 401k to the max since they were created and I have begun to make my makeup contributions.It’s lost about 40% is now worth about $600,000. The wife has just started partially funding her 403b and is worth about $16,000. She paid the college tuition for the kids and makes $50,000 to my $100,000.
One of the dilemas we face is the current funding of the Roth IRAs. She gets no match for her 403b and I get full 6%. We’re getting stretched to make all allowable contributions and have to make a choice to max funding the 401k and 403b with all pretax dollars, or fund the Roth IRAs with after tax (25% bracket)
dollars. We have been so blessed with good fortune ( except for the present turmoil that has decimated account balances) and want to make the right decision and hopefully retire within 5-7 years. I would much rather put all of our money in an account for us instead of part us and part Uncle Sam. I know a lot of people wish they had our problem. What do you suggest?
Thanks again for a great website!!
Your question is regarding the choice of pretax vs post tax retirement savings. A favorite topic for me. First, if you haven’t seen these two articles of mine,
http://www.blog.joetaxpayer.com/archives/122
http://www.joetaxpayer.com/toomuch.html
please take a moment to read.
I then suggest a visit to Fairmark to understand my next remarks.
When pointing people toward pretax savings, I continue to make the assumption that it’s tough to ‘save your way to the next tax bracket’. But, with two defined benefit pensions, you may be hitting that point. At $150K, you are at the very top of the 25% bracket. (in 2009, the standard deduction and 2 exemptions total $18,700, and the 25% bracket ends at $137,050 taxable income).
Now, to plan forward, you need to total all expected (taxable) income. Add the pensions, along with the expected distributions from the 401(k)s/IRAs. With just over $600K, we’ll hope the combination of aggressive savings along with a recovered market gives you ~ $1M. You should expect to be able to withdraw about $40K/yr from that. This may be all I can offer as only you know the pension projection. If it’s on the high side, you will likely retire in the 25% bracket I believe your in now. If it’s on the low side, you may very well be on track to be in the 15% bracket, and the pretax account is strongly suggested. For me, this dialog is more about showing you the path to your wise decision making than to just offer you an unexplained answer. This is a great question, and I may include this in a post in the next few weeks, as many are trying to make this same decision.
Joe