It’s not always your best option.
401k, IRA: How to choose a retirement plan that’s best for you
There are many different retirement savings plans – traditional IRA, Roth IRA, 401k. Here’s how to choose the one that will help you reach your goals.
Finding room for retirement savings in your budget is crucial if you hope to one day leave the workforce. But equally as important is choosing the right home for your money so it grows quickly and is accessible when you need it.
A lot of people toss cash in their 401(k)s just because they’re there – and that could be a smart decision for some. But not all 401(k)s are created equal. Here are three signs yours probably isn’t the right home for your savings.
1. The 401(k) doesn’t offer a match
A 401(k) is a great place to park your retirement savings if your employer matches some of your contributions. If you don’t claim your match, you could miss out on what’s essentially a bonus that could be worth hundreds or even thousands of dollars per year. And that money could grow to be worth tens of thousands of dollars by the time you retire.
But not all employers offer matching contributions to their employees. If your company doesn’t, it might not be the best home for your savings. You’ll have to weigh your investment options to decide.
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There are IRAs if you don’t feel your 401(k) is a good fit. These accounts give you a lot more freedom to invest how you’d like, and you can choose whether you want to pay taxes on your savings upfront or when you withdraw the money later. If you max out your IRA for the year, you can always return to saving in your 401(k).
2. The 401(k) has high fees
All 401(k)s charge fees, but how much employees pay vary from one company to another. There are administrative fees for things like record keeping and maintaining the website where you can view your balance and update your investments. And then there are investment fees, which depend on what funds you invest your money in.
You may be able to reduce the latter by changing your investments, but you’re also limited to the options your employer gives you. If it only offers expensive mutual funds with expense ratios – annual fees charged as a percentage of your assets – greater than 1%, it’s probably not your best option.
This is another scenario where an IRA might be a better choice. Since these accounts give you a lot more freedom to invest how you wish, you have more control over what you pay in fees. By focusing on low-cost investments, like index funds, you can grow your wealth quicker and hold on to more of your earnings.
3. You plan to retire early
Most 401(k)s prohibit you from taking money out of your 401(k) before age 59½ without a qualifying reason. There is an exception, known as the Rule of 55, that enables you to make withdrawals from your most recent employer’s 401(k) without penalty if you retire in the year you turn 55 or later. But if you plan to retire earlier than this, a 401(k) probably isn’t the best home for all your savings.
You can still keep some of your money here, but you may also want to keep some in an account that enables you to access your savings more easily. A taxable brokerage account is one option. These accounts don’t offer the same tax breaks as retirement accounts, but there are no limits on how much you can invest annually or what you can invest in. You can also make withdrawals at any time.
You could also consider a Roth IRA. You fund these accounts with after-tax dollars, and that enables you to withdraw your contributions tax-free at any time. That said, you could still face taxes and/or penalties if you withdraw your earnings before you turn 59½ and haven’t made your first contribution at least five years earlier. But if you’ve contributed a substantial sum to your Roth IRA over the years, you may be able to get by withdrawing contributions alone until you’re old enough to tap your other retirement account funds.
A 401(k) could still be a great option for your savings if these situations don’t apply. But it’s always a good idea to explore all your choices before you decide where to place your retirement funds. Make this a part of your annual retirement plan review so you don’t miss out on a better account that might be available to you.
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