Saving for retirement is a big deal. People set aside a fraction of their monthly income to ensure they have money for retirement. 401k and IRA are the two most popular retirement accounts, but which one is better for you?

Here’s a guide to help seniors understand the IRA vs 401k  discussion.

What is a 401k? 

A 401k is a retirement account you obtain through your employer. With each paycheck, you contribute a small amount to your investment account. Many employers will match your contributions up to a certain percentage, leading employees to participate in their company’s retirement program. 

401k pros

The primary advantage of your 401k is the matching contributions — it’s an easy way to double your retirement money. In addition to the matching, people  prefer 401ks for the following reasons:

  • High contribution limits: In 2023, the Internal Revenue Service (IRS) increased the annual 401k contribution limit to $22,500 — a $2,000 increase from 2022. 
  • Withdrawals: Once you turn 59 1/2 years old, you can withdraw from your 401k without a penalty. This advantage helps older adults who need the money in emergencies but can’t retire yet. 
  • Tax advantage: You contribute to a traditional 401k with pre-tax dollars. Thus, your annual tax filings will show less earnings and lower your tax liability. 

401k cons

Investing in a 401k is a smart option but has some drawbacks. These cons show why some people opt for an IRA versus a 401k:

  • Limited options: With a 401k, you may have limited investment options. Your employer will pick investment strategies for you or only allow a few choices. For example, your company’s 401k plan may only invest in bond funds, whereas you could want individual stocks for a more aggressive approach. 
  • Control: Seniors may need to alter their retirement plan, but it’s harder to do with a 401k. You typically have less power because the 401k administrator handles your plan, reducing the flexibility if you need to switch providers, for example. 
  • Penalties: If you need to withdraw before age 59 1/2, the IRS taxes your withdrawals at a 10% rate because of the distribution. In 2020, the SECURE Act lowered the minimum age for in-service distributions from 62 to 59.5, helping seniors who reach 60 and need to withdraw.

Should seniors have a 401k?

A 401k is an excellent retirement strategy for seniors still working. Take advantage of matching contributions if your employer offers this benefit because it doubles the money in your retirement account. Generally, only full-time employees will have a 401k, but it depends on your employer. Some companies offer a 401k plan for part-time employees.

What is an IRA?

An IRA is an individual retirement account that allows seniors slightly more control of their retirement funds. There are two types of IRAs people should know — traditional and Roth.  

Traditional IRAs let you deduct contributions from your taxes, meaning the government will tax your withdrawals in retirement. Conversely, you contribute after-tax dollars to a Roth IRA without worrying about these taxes in retirement. 

IRA pros

An IRA can be advantageous because you have more control. Here are other pros for having this retirement account:

  • Fluctuating contributions: IRAs let you control how much money you invest each month. If you’re running low on cash, you can wait until next month to contribute to your IRA. However, you can immediately deposit the funds into your account if you come into extra money.
  • Diversification: IRAs let you choose investments to diversify your portfolio more than a 401k can. For example, seniors can invest more aggressively with mutual funds or remain careful with low-risk bonds.
  • Lower fees: IRAs typically have lower management fees depending on the service you use. Some wealth management companies have commission-free or low-cost mutual funds to lower expenses.

IRA cons

As great as they are, IRAs also have some drawbacks. These cons show why you may reconsider the IRA and 401k debate:

  • Contribution limits: In 2023, you can only contribute $7,500 annually to an IRA if you’re 50 or older. People under 50 can only contribute $6,500 annually. Either way, the contribution limit is less advantageous for seniors considering an IRA.
  • Income eligibility: IRAs also come with a maximum income allowed. Seniors making over $153,000 are ineligible to contribute to an IRA. 
  • Required minimum distributions (RMDs): When you turn 72, the IRS says you must withdraw a minimum amount of money from your IRA. Some seniors want to wait as long as possible before removing funds, making RMDs inconvenient for their retirement plan.

Should seniors have an IRA?

Seniors would benefit more from an IRA if they want more control over investing their retirement money. Plus, IRAs help if there’s a gap in your retirement savings. Older adults aiming to retire in a few years can aggressively invest in mutual funds or individual stocks to rapidly grow their wealth.

IRAs also benefit seniors who don’t have an employer-sponsored retirement plan. You may be an independent contractor, self-employed, or a small business owner. Regardless, this retirement plan is advantageous to you.

Can you have both IRA and 401k? 

Can you contribute to a 401k and an IRA? Yes, you can defer money into separate 401k and IRA accounts. This strategy benefits seniors who want to maximize their retirement savings and diversify their portfolios. Before considering this strategy, examine your monthly income to ensure you have enough money for bills and emergencies.

Can you roll over accounts?

If your employment status changes, you may need to switch accounts. Luckily, seniors can roll over their 401k into an IRA and vice versa. You can do a direct or indirect rollover with a 401k into an IRA. Rolling over your IRA into a 401k is more complex, depending on the company’s regulations. 

If you roll over a 401k into an IRA, you’ll need to use the following steps:

  • Research: Determine which type of IRA is best for you and find your preferred financial institution or brokerage firm to open your account.
  • Paperwork: After deciding on your IRA, fill out rollover paperwork with your 401k and IRA administrators.
  • Confirmation: Once you initiate the rollover, verify with the administrators from both sides that the transaction was successful. A lot of money is at stake, so you can’t be too careful here. 

Picking a retirement account

Retirement savings can be confusing. How can you pick the best account for yourself? Knowing the difference between a 401k and an IRA is essential. 

Consider your employment status and your company’s retirement policies. If you’re self-employed, an IRA may be better for you. However, you can contribute to both IRA and 401k. 

Jack Shaw is a writer and editor for the lifestyle magazine Modded, where he has explored topics of health, wealth and relationships. He’s as a car enthusiast and lover of nature, trying to enjoy life one day at a time.

•August 9, 2023