IRA vs. 401(k)

Many people find all the options that are available when it comes to retirement planning to be quite confusing.

If you are one of those, this article is dedicated to explaining the differences between a 401 (k) plan and an IRA (Individual Retirement Account).

There will be many terms you will come across during your research that will be somewhat confusing until you get the terminology down. The path to financial doesn't have to be as complicated as we tend to make it.

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I would like to take this opportunity to encourage you to seek the guidance and advice of a professional financial planner. The resources and knowledge that a competent financial advisor can share with you will be invaluable when it becomes time to make the decision that will affect how your retirement savings are put to work for your retirement.

We go to a mechanic for mechanical advice (at least I do), so it only makes sense that we would go to someone who has trained in financial matters for financial advice.

Getting back to business, when it comes to financial retirement planning you should find that both IRAs and 401 (k) plans have strengths and weaknesses. There are also limitations as to how beneficial they can be when used in combination with one another as well as their own limitations. Every benefit that aids you in taxes and retirement should be considered carefully before leaping.

Let's first look at the 401(k) plan. This is a plan that offers a few benefits that are much preferable to many over other retirement plans.

The first thing you might want to consider is that you can invest up to 15% of your salary or a maximum of $15,000 per year (as of 2006).

Of course that is assuming that your employer doesn't have limits on how much you can invest. The money invested in your 401(k) account is pre tax money so it lowers the amount of taxes that you are paying out of each paycheck.

Many people also find that because the money is taken from their checks before it arrives it is far less painless to part with. As someone who has closely watched taxes, FICA, and Fido get my money for years, I can say that it is no less painful for me but some find it comforting and that is a real benefit.

Finally, and perhaps the most important thing to consider is that many employers will match a percentage of your contribution up to a certain amount each check. As an employee this is a boost to your investment that is well deserved and hard earned.

I hope you appreciate the implications it has on your future earnings. You should keep in mind that the penalties for accessing these funds earlier are harsh indeed in order to discourage this practice from occurring. Take care that you do not over-invest in these funds to the point that you will need to access them in times other than dire emergencies.

IRAs are another creature all together. You will find much stricter limitations on IRAs than on 401(k) plans beginning with the fact that if your employer offers a 401(k) you must make very little money in order to qualify for the tax deductions that this particular retirement fund generally allows. The maximum yearly contribution for your IRA will be $4,000 or 100% of your annual income; whichever is greater up until the age of 49. Once you've reached the age of 50 you can invest an additional $1,000 to your fund.

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The other major drawback when it comes to an IRA is the fact that you must begin receiving payments at the age of 70.5 from your account. You will also be heavily penalized if you make an early withdrawal from these funds.

Whether you choose a 401(k) plan, a Traditional IRA, or both for your financial retirement investments, I hope you will take the time to discuss the benefits and disadvantages of each with your financial advisor before making your final decision.