401k vs. Traditional IRA -- Pros/Cons

Your employer offers you a 401k, and just for making earned income you are also allowed to participate in an IRA. Now, they are both retirement accounts and both work the same as far as taxes go. So, what are the pros and cons for each?

401k

Pros:

- Most employers will give you a match of what you contribute. For example, you may get a 100% up to 4% of your salary. So if you contribute $200 a month and it equals 4%, they will match that $200 every month.

- The 401k contribution comes out of your paycheck and is automatically deducted off of your taxable income.

- You can contribute up to $16,500 (for tax year 2009) if you are below 50, and up to $21,500 if you are 50 or older.

Cons:

- You are limited to the investment decisions you can make. Usually you will have a choice of five to twenty mutual funds and a stable value fund option. So, that means you can do a lot of stock market investing.

- You don't have an advisor tagged to that account who you can go to for advice, because this is a work-sponsored plan and you lose the ability to make money as efficiently as possible.

- If you withdraw money from the plan, the plan may withhold 20% for taxes upfront (most plans do this). Also, the plan may not allow any partial 401k withdrawals, it may make you withdraw everything. Remember that if you file for bankruptcy they cannot touch your retirement accounts, Do It Yourself Bankruptcy is a good resource to use in this situation.

IRA

Pros:

- Depending on the institution you use, you will be able to have every investment choice open to you (stocks, bonds, mutual funds, annuities, CDs, etc.)

- You will be able to pick an advisor who can give you detailed advice on what to do.

- You can take partial withdrawals from the plan, and you don't have to have any tax withheld upfront. However, you cannot take unsecured personal loans from your IRA account.

Cons:

- There is no match on your contributions, because it is not an employer plan, so what you put in yourself is what you have.

- The contribution limit is currently $5,000 for people under 50, $6,000 for those above. Also, the contribution may or may not be tax deductible, it depends on your income and how you file. If you make too much money it may not be much of a benefit to have an IRA. I would consult the IRS tax guidelines for IRA contributions.

Read more about 401k rollovers to an IRA

Conclusion: If you aren't sure about your 401k plan investments or generally enjoy investing, look into starting an investment club to learn more. 401k accounts are great for people still working, because you in the accumulation phase of your life. IRAs are great for people who are about to retire, because you are in the income/withdrawal phase and advice will be more important. Remember that when you leave an employer, you can rollover your 401k plan into an IRA or another 401k for no cost.

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