Retirement investing: Is an IRA or 401(k) right for you?

When saving and investing for retirement, one of the first questions that pops up is whether an IRA or a 401(k) is the best place to park your cash.

The answer, as is often the case in investing, is that it depends.


Kimberly Clouse, Covestor’s Chief Client Advocate and Advisory Board Chair, in a recent Covestor Radio appearance discussed the differences between various types of retirement accounts. (The full audio interview is embedded at the bottom of this blog post.)

She covered several different types of individual retirement accounts (IRAs), such as traditional IRAs, Roth IRAs and Simplified Employee Pension (SEP) IRAs.

Clouse also talked about employee-sponsored 401(k) accounts and how they stack up against IRAs.

Here are some of the basics of common IRAs and 401(k)’s:

Traditional IRA

  • A retirement savings plan that lets individuals contribute pretax earnings to an account held in custody by a financial institution.
  • Investments accumulate tax-deferred until distributed, at which time the earnings are subject to income tax.
  • Withdrawals made prior to age 59.5 are subject to a 10% penalty unless certain special circumstances apply, while withdrawals must begin the year the individual turns age 70.5.
  • Contributions are subject to annual limits depending on the age of the account owner. You can contribute up to $5,500 to an IRA in 2014, or $6,500 if you are at least 50 years old. Contribution rules may apply, however, if you work for a company that offers a 401(k).

Rollover IRA

  • A traditional IRA that receives assets directly from an employer-sponsored retirement plan such as a 401(K), within 60 days of distribution from the plan.
  • Commonly used when employees are changing jobs or retiring.

Roth IRA

  • A retirement savings plan similar to a Traditional IRA but with some notable differences.
  • For example, unlike a Traditional IRA, contributions are non-deductible, while distributions are not taxed and can begin at any time. This feature can give older investors a bit more flexibility
  • Also, a Roth IRA owner may contribute after age 70.5 if he or she has earned income.
  • You pay income tax at your current rate on the amount you contribute, and any withdrawals you make in retirement will be tax-free, so paying income at a current rate can be especially beneficial to workers who are currently in lower tax brackets.
  • Not everyone is eligible to contribute to Roth accounts.

Simplified Employee Pension (SEP) IRA

  • A tax-deferred retirement plan, similar to a traditional IRA, designed for small businesses and self-employed individuals in which an employee can set aside a percentage of pre-tax income into the plan.
  • A vehicle for tax-deferred investing when saving for retirement, but the start-up and operating costs are much lower than traditional retirement plan.
  • Employers can generally contribute up to 25% of each employee’s pay, which allows for flexible annual contributions.
  • Only the employer (not the employee) contributes to a SEP IRA. The employer must contribute equally for all eligible employees.

Traditional 401(k)

  • A retirement plan sponsored by an employer.
  • A tax-deferred plan — taxes aren’t paid until money is withdrawn from the account.
  • Can allocate up to $17,500 in 2014 for retirement, before any taxes are taken out. If you’re over the age of 50, you can contribute $23,000.
  • Some companies “match” employee contributions, up to a certain limit. An example: If a company match is 3%, and if you make $50,000 a year, you should invest $1,500 to “max out” the match.

Roth 401(k)

  • Similar to a traditional 401(k), but contributions are made after taxes, rather than pre-tax, so current taxable income is not affected.
  • Any withdrawals you make in retirement will be tax-free.

So that’s your helpful list to consult when you’re thinking about whether an IRA is 401(k) is right for you. Remember, the important thing is to get started on your retirement investing as soon as possible, since time is your most powerful ally.

The full Covestor Radio interview with Kimberly Clouse is embedded below:

Continue learning: Is your 201(k) back to a 401(k)?

DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. Neither Covestor Limited nor its representatives are engaged in rendering tax, accounting or legal advice. A qualified professional should be consulted regarding the effect of such considerations on the matters covered in this article. Past performance is no guarantee of future results.