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The IRA and the 401(k)

The IRA and the 401(k)

Comparing their features, merits, and demerits. 

How do you save for retirement? Two options probably come to mind right away: the IRA and the 401(k). Both offer you relatively easy ways to build a retirement fund. Here is a look at the features, merits, and demerits of each account, starting with what they have in common.

Taxes are deferred on money held within IRAs and 401(k)s. That opens the door for tax-free compounding of those invested dollars – a major plus for any retirement saver. (1)

IRAs and 401(k)s also offer you another big tax break. It varies depending on whether the account is traditional or Roth in nature. When you have a traditional IRA or 401(k), your account contributions are tax deductible, but when you eventually withdraw the money for retirement, it will be taxed as regular income. When you have a Roth IRA or 401(k), your account contributions are not tax deductible, but if you follow Internal Revenue Service rules, your withdrawals from the account in retirement are tax-free. (1)  

Generally, the I.R.S. penalizes withdrawals from these accounts before age 59½. Distributions from traditional IRAs and 401(k)s prior to that age usually trigger a 10% federal tax penalty, on top of income tax on the withdrawn amount. Roth IRAs and Roth 401(k)s allow you to withdraw a sum equivalent to your account contributions at any time without taxes or penalties, but early distributions of the account earnings are taxable and may also be hit with the 10% early withdrawal penalty.1  

You must make annual withdrawals from 401(k)s and traditional IRAs after age 70½. Annual withdrawals from a Roth IRA are not required during the owner’s lifetime, only after his or her death. Even Roth 401(k)s require annual withdrawals after age 70½. (2)

Now, on to the major differences.

Annual contribution limits for IRAs and 401(k)s differ greatly. You may direct up to $18,500 into a 401(k) in 2018; $24,500, if you are 50 or older. In contrast, the maximum 2018 IRA contribution is $5,500; $6,500, if you are 50 or older. (1)

Your employer may provide you with matching 401(k) contributions. This is free money coming your way. The match is usually partial, but certainly, nothing to disregard – it might be a portion of the dollars you contribute up to 6% of your annual salary, for example. Do these employer contributions count toward your personal yearly 401(k) contribution limit? No, they do not. Contribute enough to get the match if your company offers you one. (1)

An IRA permits a wide variety of investments, in contrast to a 401(k). The typical 401(k) offers only about 20 investment options, and you have no control over what investments are chosen. With an IRA, you have a vast range of potential investment choices. (1,3)

You can contribute to a 401(k) no matter how much you earn. Your income may limit your eligibility to contribute to a Roth IRA; at certain income levels, you may be prohibited from contributing the full amount, or any amount. (1)

If you leave your job, you cannot take your 401(k) with you. It stays in the hands of the retirement plan administrator that your employer has selected. The money remains invested, but you may have less control over it than you once did. You do have choices: you can withdraw the money from the old 401(k), which will likely result in a tax penalty; you can leave it where it is; you can possibly transfer it to a 401(k) at your new job; or, you can roll it over into an IRA. (4,5)

You cannot control 401(k) fees. Some 401(k)s have high annual account and administrative fees that effectively eat into their annual investment returns. The plan administrator sets such costs. The annual fees on your IRA may not nearly be so expensive. (1)

All this said, contributing to an IRA or a 401(k) is an excellent idea. In fact, many pre-retirees contribute to both 401(k)s and IRAs at once. Today, investing in these accounts seems all but necessary to pursue retirement savings and income goals.


J Rucci

Justin D. Rucci, CFP®
Wealth Advisor
Warren Street Wealth Advisors

 

 

 

Justin D. Rucci is an Investment Advisor Representative of Warren Street Wealth Advisors, a Registered Investment Advisor. The information contained herein does not involve the rendering of personalized investment advice but is limited to the dissemination of general information. A professional advisor should be consulted before implementing any of the strategies or options presented.

This material was prepared by Marketing Pro, Inc. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Past performance may not be indicative of future results. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance, strategy, and results of your portfolio. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. Nothing in this commentary is a solicitation to buy, or sell, any securities, or an attempt to furnish personal investment advice. We may hold securities referenced in the blog and due to the static nature of the content, those securities held may change over time and trades may be contrary to outdated posts.

Citations.

1 – nerdwallet.com/article/ira-vs-401k-retirement-accounts [4/30/18]
2 – irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions [5/30/18]
3 – tinyurl.com/y77cjtfz [10/31/17]
4 – finance.zacks.com/tax-penalty-moving-401k-ira-3585.html [9/6/18]
5 – cnbc.com/2018/04/26/what-to-do-with-your-401k-when-you-change-jobs.html [4/26/18]

2015 IRA Deadlines Are Approaching

Here is what you need to know.

Provided by: Warren Street Wealth Advisors

 

Financially, many of us associate April with taxes – but we should also associate April with important IRA deadlines.

 

*April 1 is the absolute deadline to take your first Required Mandatory Distribution (RMD) from your traditional IRA(s).

*April 15 is the deadline for making annual contributions to a traditional or Roth IRA.1

 

Let’s discuss the contribution deadline first, and then the deadline for that first RMD (which affects only those IRA owners who turned 70½ last year).

 

The earlier you make your annual IRA contribution, the better. You can make a yearly Roth or traditional IRA contribution anytime between January 1 of the current year and April 15 of the next year. So the contribution window for 2014 is January 1, 2014- April 15, 2015. You can make your IRA contribution for 2015 anytime from January 1, 2015-April 15, 2016.2

 

You have more than 15 months to make your IRA contribution for a given year, but why wait? Savvy IRA owners contribute as early as they can to give those dollars more months to grow and compound. (After all, who wants less time to amass retirement savings?)

 

You cut your income tax bill by contributing to a deductible traditional IRA. That’s because you are funding it with after-tax dollars. To get the full tax deduction for your 2015 traditional IRA contribution, you have to meet one or more of these financial conditions:

 

*You aren’t eligible to participate in a workplace retirement plan.

*You are eligible to participate in a workplace retirement plan, but you are a single filer or head of household with modified adjusted gross income of $61,000 or less. (Or if you file jointly with your spouse, your combined MAGI is $98,000 or less.)

*You aren’t eligible to participate in a workplace retirement plan, but your spouse is eligible and your combined 2015 gross income is $183,000 or less.3

 

If you are the original owner of a traditional IRA, by law you must stop contributing to it starting in the year you turn 70½. If you are the initial owner of a Roth IRA, you can contribute to it as long as you live provided you have taxable compensation and MAGI below a certain level (see below).1,3

 

If you are making a 2014 IRA contribution in early 2015, be aware of this fact. You must tell the investment company hosting the IRA account what year the contribution is for. If you fail to indicate the tax year that the contribution applies to, the custodian firm may make a default assumption that the contribution is for the current year (and note exactly that to the IRS).4

 

So, write “2015 IRA contribution” or “2014 IRA contribution” as applicable in the memo area of your check, plainly and simply. Be sure to write your account number on the check. Should you make your contribution electronically, double-check that these details are communicated.

 

How much can you put into an IRA this year? You can contribute up to $5,500 to a Roth or traditional IRA for the 2015 tax year, $6,500 if you will be 50 or older this year. (The same applies for the 2014 tax year). If you have multiple IRAs, you can contribute up to a total of $5,500/$6,500 across the various accounts. Should you make an IRA contribution exceeding these limits, you will not be rewarded for it: you will have until the following April 15 to correct the contribution with the help of an IRS form, and if you don’t, the amount of the excess contribution will be taxed at 6% each year the correction is avoided.1,4

 

If you earn a lot of money, your maximum contribution to a Roth IRA may be reduced because of MAGI phase-outs, which kick in as follows.3

 

2014 Tax Year                                                          2015 Tax Year

Single/head of household: $114,000 – $129,000          Single/head of household: $116,000 – $131,000

Married filing jointly: $181,000 – $191,000                      Married filing jointly: $183,000 – $193,000

Married filing separately: $0 – $10,000                 Married filing separately: $0 – $10,000

 

If your MAGI falls within the applicable phase-out range, you may make a partial contribution.3

 

A last-chance RMD deadline rolls around on April 1. If you turned 70½ in 2014, the IRS gave you a choice: you could a) take your first Required Minimum Distribution from your traditional IRA before December 31, 2014, or b) postpone it until as late as April 1, 2015.1

 

If you chose b), you will have to take two RMDs this year – one by April 1, 2014 and another by December 31, 2014. (For subsequent years, your annual RMD deadline will be December 31.) The investment firm hosting your IRA should have already notified you of this consequence, and the RMD amount(s) – in fact, they have probably calculated the RMD(s) for you.5

 

Original owners of Roth IRAs will never face this issue – they are not required to take RMDs.1

 

Warren Street Wealth Advisors

190 S. Glassell St., Suite 209

Orange, CA 92866

714-876-6200 – office

714-876-6202 – fax

714-876-6284 – direct

 

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

 

Citations.

1 – irs.gov/Retirement-Plans/Traditional-and-Roth-IRAs [11/3/14]

2 – dailyfinance.com/2014/12/06/time-running-out-end-year-retirement-planning/ [12/6/14]

3 – asppa.org/News/Browse-Topics/Sales-Marketing/Article/ArticleID/3594 [10/23/14]

4 – investopedia.com/articles/retirement/05/021505.asp [1/21/15]

5 – schwab.com/public/schwab/nn/articles/IRA-Tax-Traps [6/6/14]