Photo of Ray Ferrara CFP Ray Ferrara CFP Jun 02, 2020

For most people, retirement plans often come in the form of 401(k)s and IRAs — but how do you know which one is best for you? And how do you choose between Roth and traditional options? First things first, we should get down to the basics of what these main retirement plans  are and the benefits to each. Then, we will discuss how to match your current financial situation and retirement goals to the best plan. 

Let us start with the basics.

For simplicity sake, there are three common types of retirement plans that people can choose from: 401(k), IRA and Roth IRA. Here is a quick overview of each of these options:

  • 401(k) — A 401(k) is a defined retirement plan offered by an employer to an employee. The advantage here is that employers often offer to match a certain percentage of your contributions. As of 2020, the maximum contribution for a person under the age of 50 is $19,500 annually. This rate increases to $26,000 for people age 50 and above. 
  • IRA —An IRA is an Individual Retirement Account, which is available to all adults who have an earned income. The maximum contribution for an IRA is $6,000 as of 2020 for people under 50 and $7,000 for those 50 and older. All funds withdrawn from an IRA are subject to taxation after withdrawal.
  • Roth IRA — Similar to an IRA, a Roth IRA is available to any adult who has earned income, and the limit for annual contribution is $6,000 (or, again, $7,000 if you are 50 or older). Where a contribution to a traditional IRA may be tax deductible, contributions to a Roth IRA are made with after-tax dollars. However, because your contributions have already been subjected to taxation, any withdrawals after five years from this account are not subject to tax when withdrawn for retirement..  Contributions can be withdrawn at any time without penalty or tax.

There are additional retirement plans, such as 403(b), 457(b), SIMPLE IRA, and HSA, but the majority of Americans will take advantage of the three options listed above.

What is the best option for retirement?

If you only have the income to contribute to one of these retirement plans, then contribute to your 401(k) if it has an employer contribution match. Do whatever you can to reach the match contribution maximum, i.e. if your employer is offering to match 3%, then you should contribute at least 3%. Typically, this contribution is deducted directly from your payroll, so you do not see the money leaving your account. For many people, that is an easier way to save on a regular basis. 

If there is no match, then you may want to consider investing in an IRA or Roth IRA rather than a 401(k) through your employer because an IRA typically allows for a broader range of investment options compared to the narrow focus of a company-offered 401(k). Most companies limit their 401(k) investments to equity and fixed income mutual funds,  and money market instruments, according to Investopia. If you want a broader range of selections or more control of where you are investing your retirement plan, an IRA is your better option. 

If you can afford to contribute to both a 401(k) and an IRA, you should. A 401(k) allows for higher contributions and may include an employer match, but as long as you are an employee, it does not typically allow funds to be withdrawn prematurely. You can take a loan against your 401(k), but it must be paid back within five years, in most cases. However, funds from an IRA can be withdrawn at any time — though we do not recommend it unless absolutely necessary because you will have to pay taxes, a 10% penalty if under age 59 ½ and it will disrupt your return on investment. Depending on whether or not you chose a traditional or Roth IRA, your withdrawal may be taxed, but it does allow you to access your money prematurely in the event of an emergency. 

Getting started toward your retirement goals

To make the best retirement plan decision, it is a good idea to speak with a CERTIFIED FINANCIAL PLANNER™ professional who can direct you in the option that best fits your current financial state and your future financial goals. At ProVise Management Group, we will provide a personalized plan for you at a fiduciary standard of care and offer an unconditional money-back guarantee. If for any reason you are not satisfied with the written plan, simply return it to us and we will refund 100% of the fee paid. 

Once you are ready to work together, we will create an implementation strategy and establish a monitoring system that meets your needs. Contact our ProVise team to schedule a consultation today.