Some resources can help you prepare financially for retirement, like retirement accounts. Saving money for retirement while also getting a tax break is a 2-for-1 benefit that can work wonders for retirees.
There are a handful of retirement accounts available, with the most popular being the 401(k) because it is offered through employers. Many people think about maxing out their 401(k), and while that’s an admirable goal, there may also be a better path to retirement savings.
Get matched by your employer, then focus on the IRA
Employer matching is when your company matches a certain percentage or amount of your 401(k) contributions. The minimum amount you must contribute to a 401(k) will be matched by your employer. Contributing anything less means leaving free money on the table.
Once you’re contributing the maximum that matches your employer, I suggest you focus your attention on maxing out your IRA rather than maxing out your 401(k). Once you’ve maxed out the IRA, you should focus again on maxing out your 401(k).
The maximum you can contribute to an IRA in 2024 (traditional and Roth combined) is $7,000. If you’re age 50 or older, you can add an additional $1,000 catch-up contribution, making it $8,000. The most you can contribute to a 401(k) in 2024 is $22,500 ($30,000 if you’re age 50 or older), so the IRA limit is much lower and it’s more manageable to max it out.
Of course, if you are financially able to do both, do so. However, this is not an option for most people.
Two Main Types of IRAs to Consider
The two main types of IRAs are traditional and Roth, each with unique benefits.
A traditional IRA is closer to a 401(k) because each allows you to deduct your contributions from your taxable income for the year. In the case of a Traditional IRA, whether your contributions are deductible depends on your filing status, income and whether you are covered by a work-sponsored retirement plan.
With a Roth IRA, your tax savings carry over into retirement. If you’re age 59 1/2 and made your first contribution at least five years ago, you contribute after-tax money and then take tax-free withdrawals in retirement.
It is beneficial to have multiple investment options
I recommend prioritizing an IRA rather than maxing out your 401(k) because IRAs provide benefits not found in a 401(k).
To start, you have plenty of investment options with an IRA. In a 401(k), you are forced to choose from a range of options. IRAs allow you to invest in virtually any stock or exchange-traded fund (ETF) in your regular brokerage account.
The freedom to customize your investments is important in investing, especially retirement investing. Everyone’s risk tolerance, financial and retirement goals, and time frame are different. What works for one person may be counterproductive for someone else.
For example, in your 30s, when you are within a decade of retirement it is generally easier to take more risk for the opportunity of higher returns and preserve what you have achieved up to that point. Requires more focus.
Withdrawal flexibility can help with major life events
IRAs also have more flexible early withdrawal rules. Generally, when you make early withdrawals from a retirement account, you will be charged a 10% penalty and have to pay taxes on the amount withdrawn. However, IRAs have more exceptions to this rule that can benefit you for various life events.
First-time home buyers can withdraw up to $10,000 toward their purchase; You can cover eligible education expenses like tuition, books and other student fees; You can cover your health care premiums while you are unemployed; And some other exceptions that don’t apply to 401(k).
Choosing Between a Traditional and Roth IRA
Choosing between a traditional and Roth IRA generally depends on your current tax rate versus your projected tax rate in retirement and when you want to pay taxes.
A traditional IRA may be a good option for people who are in their peak earning years who expect to be in a lower tax bracket in retirement, because you can take tax breaks when your bracket is higher. Conversely, a Roth IRA may benefit someone who anticipates being in a higher bracket in retirement because you can pay taxes at a lower rate now.
Regardless of your choice, it’s important to consider its association with a 401(k). IRAs and 401(k)s have advantages and disadvantages and are best used to tackle retirement savings as a team. The more resources you use, the better, as you maximize the advantages of each while minimizing the disadvantages.