SavvySugar

What's the Difference Between an IRA and a 401k?

SavvySugar — Fri, 13 Mar 2009 09:30:40 -0700

One of the most common questions I get from readers is, "What's the difference between an IRA and 401(K)?"

If you're an athlete, 401(k) sounds like it should be the length of some torturous marathon. Of course, IRA might evoke images of the Irish Republican Army. I suggest you ignore your immediate word associations and begin thinking about your future immediately. Retirement as a goal really is like a long, slow marathon, and a well mapped out plan makes finishing on your feet a real possibility. I have graphed out the differences between IRAs and 401(k) accounts below. Here's to the long haul!

Name of plan	Purpose	Who can invest	IRS Contribution Limit for 2009	Taxes
401(k)	Tax-deferred retirement savings account offered by many employers.	If your employer offers it, you may be eligible. Check your employer’s plan for requirements.	$16,500 (plus up to $5,000 more if you are 50 or more). Your Employer’s Plan rules may also further limit your contributions.	Deferred until retirement; taxes paid when funds are withdrawn.
Roth 401(k)	After-tax retirement savings account.	If your employer offers it, you’re eligible. Check with your employer’s plan for requirements.	$16,500	Contributions are made with after tax dollars; qualifying withdrawals aren’t subject to income tax.

See the difference between a traditional IRA and a Roth IRA when you read more.

Name of plan	Purpose	Who can invest	IRS Contribution Limit for 2009	Taxes
Traditional IRA	Individual retirement savings account.	Anyone with earned income and under age 70.5 for the year in which the contribution is made	100% of earned income or $5000 ($6000 if you are over 50), whichever is less.	Contributions may be tax-deductible depending on several factors. Withdrawals of income and pretax contributions after age 59.5 are taxed as regular income.
Roth IRA	Individual retirement savings account.	Available to single-filers making an income up to $116,000 or married couples filing jointly making a combined maximum of $169,000 annually. If you are married filing separately, talk to your tax adviser for income limits	100% of earned income or $5,000 (or $6,000 if you are over age 50) whichever is less.	Contributions are made after taxes. Withdrawals of income aren’t subject to income tax if all conditions are met. For example, your withdrawal of income won’t be taxed if at least 5 years has passed since your first Roth contribution and you are at least 59.5 years old.

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Definition: Hardship Withdrawal

SavvySugar — Wed, 24 Sep 2008 15:30:45 -0700

A hardship withdrawal is when a 401(k) account holder removes funds from her retirement savings because of circumstances like job loss, facing home foreclosure, or overwhelming medical expenses. While withdrawal is permitted during those tough times, the account holder cannot get away from the 10 percent tax penalty incurred when the funds are removed.

According to The Wall Street Journal, several 401(k) plan administrators reported a noticeable increase in hardship withdrawals this year compared to last. The shift signals that many 401(k) participants are more concerned about how they will pay their bills than saving for retirement. Administrators have also observed many employees dealing with the tough economy by reducing the amount they contribute to their retirement plans.

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Your Two Cents: Have You Started Saving For Retirement?

SavvySugar — Tue, 26 Aug 2008 14:00:10 -0700

There are a number of vehicles available to help us save for retirement. Maybe you're participating in your employer's 401(k) plan, you're saving in a separate IRA account, or you're using a combination of different accounts. Have you started saving for your golden years?

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Definition: 401(k) Debit Card

SavvySugar — Thu, 07 Aug 2008 15:30:03 -0700

A 401(k) debit card is deceivingly like the debit cards you're familiar with, except the money is drawn from your retirement savings and must be paid back to yourself with interest - essentially, it is a loan against your 401(k). You're responsible for making punctual payments, and if you miss one, you risk having to pay early withdrawal penalties.

While you'd be paying interest now, you'd really be borrowing from your future self. When you remove funds from your retirement savings it reduces the potential for compounding interest, therefore hurting your overall long-term savings goal and strategy. Do yourself a favor and pretend that 401(k) debit cards don't exist; you'll be grateful when you need to rely on those funds for living.

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Women Need to Save More to Support Their Longer Lives

SavvySugar — Thu, 10 Jul 2008 08:03:39 -0700

It may seem counterintuitive that you're presented with retirement savings options the moment you get your first job. You just started working and you're asked to consider your life when you've stopped working for good. That's reality folks, because unless you have a family fortune to count on or make serious dinero that lets you worry less, it can take your working lifetime to save enough to live during retirement.

A new study released by human resources consulting firm Hewitt Associates determined that women aren't saving enough to support them through their longer lives. Women tend to start saving later than men and are in retirement an average of three more years. Learn more about the study and how to make up for lost time when you read more.

The study surveyed projected retirement levels of about 2 million workers and used actual employee balances. Here are the key conclusions from their findings.

25 percent of women didn't contribute enough to take advantage of the company match.
Not including an employer's matching contribution, a woman who earns $57,000 a year can save an extra $81,000 by the time she retires if she boosts her contribution from 2 percent to 4 percent (an extra $95 a month).
90 percent of women were unsure about managing their finances.
Men and women are on track to save about 67 percent of what they'll actually need for retirement, and Hewitt estimates workers will need to replace 126 percent of their salary after retirement.

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Retirement Account Focus Review

SavvySugar — Fri, 21 Mar 2008 12:53:12 -0700

Over the past several weeks we've discussed different retirement options and choosing the right plan for you. We've also looked into selecting investments for your account, how much you should save for the future, and important decisions you might face when you have a retirement account. Since saving for retirement is one of the most savvy things you can do, in case you missed any of them I've rounded up all of the retirement tips. Soon you'll be polishing your plump nest egg! To see all of my tips just read more.

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Retirement Account Focus, Part VIII

SavvySugar — Mon, 17 Mar 2008 14:32:06 -0700

Some workers who have been affected by the mortgage and credit crises have been borrowing from their 401(k) accounts in order to keep up with current expenses and pay off credit card debt. When you sign up for a 401(k) plan it comes with an allowance that tells you it's an option to take a loan from your account.

You might be thinking that this isn't a big deal, and the money is yours so borrowing it from yourself shouldn't be something worth talking about. As with most things 401(k) related, there are tax considerations, penalties, and overall savings that need to be taken into account. Before you take a loan from your 401(k) be sure to consider the negative impact it can have on your nest egg when you read more.

If you find yourself in dire straights (like if your home is facing foreclosure) with nowhere to turn but your 401(k) savings, you're allowed to tap your account up to $50,000 or 50 percent of the invested amount, whichever is less. If your loan is in good standing, meaning you pay it back, you'll avoid the tax consequences that would come into play if you were to default on your loan.

The reason there are tax penalties is that a defaulted loan is treated as a withdrawal and is subject to income tax and an additional 10 percent penalty for taking an early distribution. There are other points to consider besides taxes: some plans don't allow you to make contributions while paying off a 401(k) loan and others make you wait a certain amount of time before continuing contributions. And if your employer matches contributions, you're not only missing out on your own contributions but theirs as well.

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Ask Savvy: Should I Choose a Roth 401(k) or a Traditional 401(k)?

SavvySugar — Mon, 10 Mar 2008 04:24:40 -0700

My girlfriend, a 25 year-old Human Resources Associate, manages to pay her Manhattan rent and save for retirement. She just got a great new job and asked me what direction to take with her new 401(k). Her employer offers a traditional 401(k) plan and a Roth 401(k) option, and she's not sure which one would be best for her. To see my answer just read more

This is an age old question that goes back to oh, 2006 when Roth 401(k) accounts were first introduced. The first question to ask is if your employer has the same matching contribution policy for both types of accounts. If they offer matching contributions for both accounts then keep reading, otherwise just go with the one that gets you free money!

The main difference between a Roth 401(k) and a traditional 401(k) is that the Roth version is funded with after-tax wages while the traditional 401(k) is funded with pre-tax wages. That means if you choose the Roth 401(k) you don't have to pay taxes on money pulled out in retirement, so investment earnings grow tax-free. If you choose the traditional 401(k) you would pay ordinary income tax rates on distributions. Now, what should you take from all this tax talk?

Roth 401(k)s are good options for younger workers, like my girlfriend, who are currently taxed in a lower tax bracket but expect to be taxed in a higher bracket upon retirement. If you expect to be in a similar tax bracket in retirement you can still use the Roth 401(k) to hedge against possible future government tax hikes.

Ideally, you'll contribute as much as you can to your retirement savings. If paying taxes now like you would with a Roth 401(k) would cause you to make lower contributions than you normally would, then it may not be the option for you. However, if you can keep up with your contributions I think the Roth 401(k) would be the best option for now. You could try using the Forbes Roth 401(k) Analyzer to see which is in fact a better option for you.

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Retirement Account Focus, Part III

SavvySugar — Thu, 14 Feb 2008 13:52:18 -0800

Many of you have been asking about whether or not now is a good time to invest because the market hasn't exactly been steady. It's understandable that you're protective of your hard-earned money and don't want to see your account dip because of a down market, but that's not what you should focus on when thinking about your retirement investments especially. I have an opinion of market timing that not everyone shares, but it's one that has worked for some serious professional investors. To see what it is just read more

Timing the market is one way that people get their emotions mixed up with their investments, and emotional investing is risky in itself. Rash decisions can be made when you're trying to protect not only your nest egg but your ego.

Because you're investing for the long term, your account is going to have time to ride out the market cycle - which you can't control. In fact, at the Berkshire Hathaway Annual Meeting With Shareholders on May 1, 2005, Warren Buffet admitted that he and the vice president of the company agree on their market sense: "We spend no time talking about what the stock market is going to do, because we don't know."

So, moral of the story? Don't try and time the market because there's just no point. Maybe it is time for you to look into a Roth IRA.

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Retirement Account Focus, Part II

SavvySugar — Thu, 07 Feb 2008 09:38:27 -0800

You already know the importance of investing in a 401(k) if your employer offers one, but what if that's not an option for you or you've already invested as much as your company will match? This is where an individual retirement account (IRA) comes in to play and there are two types: Roth IRA and Traditional IRA. Tax structure is the biggest difference between the two options.

If you're already participating in a tax deferred retirement plan (like a 401(k)) and your salary meets the income limitations for Roth IRAs, start investing while your salary is low enough to get in. If you're filing your taxes as single you can't earn over $95,000, and if you file jointly your income can't exceed $150,000. To learn what's so great about Roth IRAs just read more

The Roth IRA allows earned income that’s already been taxed to grow tax-free. Contributions to Roth IRAs are not tax deductible when they are made, but distributions made during retirement years are tax free. The principle (your original contributions) can also be withdrawn at any time without penalty, but earnings can't be withdrawn until age 59 1/2 without penalty.

Besides the tax free withdrawals that make a Roth IRA so attractive, another advantage is the absence of minimum withdrawal requirements. Traditional IRAs require that you make minimum withdrawals starting at age 70 1/2 whether or not you need the money, while the Roth doesn't come with this caveat.

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