{"id":409,"date":"2023-04-02T02:11:00","date_gmt":"2023-04-02T02:11:00","guid":{"rendered":"http:\/\/marshalllodge.co.uk\/?p=409"},"modified":"2023-11-23T15:19:36","modified_gmt":"2023-11-23T15:19:36","slug":"traditional-ira-vs-401k-plan-which-plan-wins","status":"publish","type":"post","link":"http:\/\/marshalllodge.co.uk\/index.php\/2023\/04\/02\/traditional-ira-vs-401k-plan-which-plan-wins\/","title":{"rendered":"Traditional IRA vs. 401(k) Plan \u2013 Which Plan Wins?"},"content":{"rendered":"<p><a href=\"https:\/\/www.goodfinancialcents.com\/how-to-make-money-blogging\/\" data-wpel-link=\"internal\" rel=\"noopener\">Financial bloggers<\/a> often portray the traditional IRA vs. the 401(k) plan as a debate, as if one plan is better than the other.<\/p>\n<p>In truth, they\u2019re very different plans, and they fill very different needs. If you can, <em><strong>you should plan to have both.<\/strong><\/em><\/p>\n<p>This is especially true if your <a href=\"https:\/\/www.goodfinancialcents.com\/401k-investment\/\" data-wpel-link=\"internal\" rel=\"noopener\">401(k) plan<\/a> is fairly restrictive. A lot of them are. They charge high fees and offer very limited investment options. A <a href=\"https:\/\/www.goodfinancialcents.com\/traditional-ira-rules-limits\/\" data-wpel-link=\"internal\" rel=\"noopener\">traditional IRA<\/a> is often the best strategy to work around those limits.<\/p>\n<p>Let\u2019s take a deep look at both plans, and particularly at where each stands out. I think you\u2019ll agree having both makes a lot of sense. It\u2019s one of the best strategies to supercharge your <a href=\"https:\/\/www.goodfinancialcents.com\/saving-for-retirement-too-late\/\" data-wpel-link=\"internal\" rel=\"noopener\">retirement savings<\/a>, especially for <a href=\"https:\/\/www.goodfinancialcents.com\/3-early-retirement-planning-ideas\/\" data-wpel-link=\"internal\" rel=\"noopener\">early retirement<\/a>.<\/p>\n<div class=\"gfc-table-of-contents gfc-table-of-contents-blockwrap gfc-blockwrap\">\n<div class=\"gfc-table-of-contents-title-container\">\n<h3>Table of Contents<\/h3>\n<\/div>\n<div class=\"gfc-table-of-contents-content\t-container\">\n<ul>\n<li><a href=\"#how-traditional-ira-works\">How Traditional IRA Works<\/a><\/li>\n<li><a href=\"#the-roth-ira-conversion\">The Roth IRA Conversion<\/a><\/li>\n<li><a href=\"#how-the-401k-works\">How the 401(k) Works<\/a><\/li>\n<li><a href=\"#the-traditional-ira-vs-the-401k-plan-the-advantages-of-each\">The Traditional IRA vs. The 401(k) Plan \u2013 The Advantages of Each<\/a><\/li>\n<li><a href=\"#why-you-should-seriously-consider-having-both-an-ira-and-a-401k\">Why You Should Seriously Consider Having Both an IRA and a 401(k)<\/a><\/li>\n<li><a href=\"#the-bottom-line-traditional-ira-vs-401k-plan-which-plan-wins\">The Bottom Line \u2013 Traditional IRA vs. 401(k) Plan \u2013 Which Plan Wins?<\/a><\/li>\n<\/ul>\n<\/div>\n<\/div>\n<h2 class=\"wp-block-heading\">How Traditional IRA Works<\/h2>\n<h3 class=\"wp-block-heading\">Basics<\/h3>\n<p><strong>IRA Contribution Limits.<\/strong> You can contribute up to $6,500 per year or $7,500 if you\u2019re age 50 or older. Contributions must be made out of <em><strong>earned income only<\/strong>.<\/em> <\/p>\n<p>That means wages, salary, commissions, self-employment income, or contract income. It does not include income from unearned sources, like pensions, <a href=\"https:\/\/www.goodfinancialcents.com\/how-to-maximize-social-security-benefits\/\" data-wpel-link=\"internal\" rel=\"noopener\">Social Security<\/a>, or investment income.<\/p>\n<p>For example, if you earn $40,000, and only $4,000 is from earned sources, your IRA contribution will be limited to no more than $4,000.<\/p>\n<p><strong>Spousal IRA Provision.<\/strong> If you\u2019re married filing jointly, and either you or your spouse has earned income and the other doesn\u2019t, you may be eligible to make a <a href=\"https:\/\/www.goodfinancialcents.com\/spousal-ira-contribution-rules-roth-or-traditional\/\" data-wpel-link=\"internal\" rel=\"noopener\">spousal IRA contribution<\/a>. <\/p>\n<p>The only requirement is that the spouse with earned income must have sufficient earned income to cover contributions to both plans.<\/p>\n<p>For example, let\u2019s say you earn $50,000 per year, and your spouse is unemployed. You can make a $6,500contribution to your own IRA and a $6,500 contribution to a spousal IRA for your spouse. That will give you a combined contribution of $13,000, which will also be fully tax-deductible.<\/p>\n<div class=\"ca-widget\" data-token=\"u892c22ad503\"><\/div>\n<h3 class=\"wp-block-heading\">Required Minimum Distributions (RMDs)<\/h3>\n<p>Like every other retirement plan \u2013 other than the <a href=\"https:\/\/www.goodfinancialcents.com\/how-much-money-do-you-need-start-roth-traditional-ira\/\" data-wpel-link=\"internal\" rel=\"noopener\">Roth IRA \u2013 traditional IRAs<\/a> are subject to <a href=\"https:\/\/www.irs.gov\/retirement-plans\/plan-participant-employee\/retirement-topics-required-minimum-distributions-rmds\" target=\"_blank\" rel=\"noreferrer noopener external\" data-wpel-link=\"external\">RMD rules<\/a>. When you turn age 73, you\u2019re required to begin receiving distributions from the plan.<\/p>\n<p>The distributions are generally based on your remaining life expectancy. And because that expectancy reduces as each year passes, the percentage distributed from your plan will increase slightly. <\/p>\n<p>In theory, the purpose is to exhaust the plan within your lifetime, providing the IRS with its expected tax revenue.<\/p>\n<h3 class=\"wp-block-heading\">Tax Deductibility of Traditional IRA Contributions<\/h3>\n<p>For most taxpayers, the contributions made toward a traditional IRA will be fully tax-deductible. This is always true when neither you nor your spouse are covered by an employer-sponsored retirement plan. <\/p>\n<p>What\u2019s more, there\u2019s no income limit on the tax deductibility of a traditional IRA contribution if neither of you is covered by an employer plan.<\/p>\n<p>If either of you are, tax deductibility may be either limited or eliminated completely.<\/p>\n<p>The tax deductibility of a traditional IRA contribution when you or your spouse are covered by an employer plan is based on your <a href=\"https:\/\/www.investopedia.com\/terms\/m\/magi.asp\" target=\"_blank\" rel=\"noreferrer noopener external\" data-wpel-link=\"external\">modified adjusted gross income (MAGI)<\/a>. That\u2019s basically your adjusted gross income for tax purposes, with certain modifications.<\/p>\n<p>If <a href=\"https:\/\/www.irs.gov\/retirement-plans\/plan-participant-employee\/2018-ira-contribution-and-deduction-limits-effect-of-modified-agi-on-deductible-contributions-if-you-are-covered-by-a-retirement-plan-at-work\" target=\"_blank\" rel=\"noreferrer noopener external\" data-wpel-link=\"external\">you\u2019re covered by an employer-sponsored plan<\/a>, you can still make a contribution to a traditional IRA. <strong>But the tax deductibility of that contribution will be determined by the following MAGI levels:<\/strong><\/p>\n<ul>\n<li>Single or head-of-household contributions are fully deductible up to a MAGI of $138,000; the deduction phases out up to $75,000, beyond which it completely disappears.<\/li>\n<\/ul>\n<ul>\n<li>Married filing jointly, or qualifying widow(er), fully deductible up to a MAGI of $218,000 (up to $228,000); deduction phases out up to $124,000, beyond which it completely disappears.<\/li>\n<\/ul>\n<ul>\n<li>Married filing separately, contribution phases out up to a MAGI of $10,000, beyond which it completely disappears (no change from 2018 to 2019).<\/li>\n<\/ul>\n<p>The numbers are different if you\u2019re not covered by an employer-sponsored retirement plan but your spouse is. In that case, the tax deductibility of your IRA contribution is subject to the following MAGI limits:<\/p>\n<ul>\n<li>Married filing jointly, fully deductible up to a MAGI of $218,000; deduction phases out up to $228,000 in 2023, beyond which it completely disappears.<\/li>\n<\/ul>\n<ul>\n<li>Married filing separately, contribution phases out up to a MAGI of $10,000, beyond which he completely disappears.<\/li>\n<\/ul>\n<h3 class=\"wp-block-heading\">Other IRA Tax Considerations<\/h3>\n<p><strong>Investment Income Tax Deferral. <\/strong>Whether or not your contributions to a traditional IRA are tax-deductible, the investment earnings you accumulate in the plan are always tax-deferred. That means you can invest without worrying about tax consequences. <\/p>\n<p>Tax-deferred investment income is worth having, even if your contributions aren\u2019t deductible. Your investment nest egg will grow much faster with tax deferral than it ever will without.<\/p>\n<h4 class=\"wp-block-heading\"><strong>Your investments will continue to grow on a tax-deferred basis until you begin making withdrawals.<\/strong><\/h4>\n<\/p>\n<p><strong>Taxability of IRA withdrawals. <\/strong>You don\u2019t begin paying taxes on your IRA until you begin taking withdrawals. You can take withdrawals beginning at age 59 \u00bd, which will be subject to ordinary income tax.<\/p>\n<p>If you made any contributions that were not tax-deductible, usually due to the income limitations described above, that portion of the distribution will not be taxable.<\/p>\n<p>For example, if you have $100,000 in an IRA account, which consists of $60,000 in accumulated investment income, $30,000 in tax-deductible contributions, and $10,000 in nondeductible contributions, then 10% of any withdrawal will not be subject to income tax.<\/p>\n<p>In that situation, if you made a withdrawal from the account of $10,000, $9,000 will be taxable. The remaining $1,000 will not ($10,000 X 10%). <\/p>\n<p>This is what\u2019s referred to as the IRS pro-rata rules. You won\u2019t be able to declare that the first $10,000 withdrawn from the plan specifically represents your nondeductible contributions.<\/p>\n<h3 class=\"wp-block-heading\">Early Withdrawal Treatment<\/h3>\n<p>If you withdraw funds from a traditional IRA before you turn 59 \u00bd, you\u2019ll be subject to ordinary income tax on the distribution, plus a <a href=\"https:\/\/www.goodfinancialcents.com\/401k-early-withdrawal-penalties-distribution-rules\/\" data-wpel-link=\"internal\" rel=\"noopener\">10% early withdrawal penalty<\/a>.<\/p>\n<p>For example, if you\u2019re in the 12% <a href=\"https:\/\/www.goodfinancialcents.com\/income-tax-guide\/\" data-wpel-link=\"internal\" rel=\"noopener\">federal income tax bracket<\/a> and you make a $10,000 early withdrawal from your plan, you\u2019ll have to pay $2,200 in tax. That\u2019s 12% in ordinary tax plus the 10% early withdrawal penalty.<\/p>\n<p>However, the IRS does have a <a href=\"https:\/\/www.irs.gov\/retirement-plans\/plan-participant-employee\/retirement-topics-tax-on-early-distributions\" data-wpel-link=\"external\" rel=\"external noopener noreferrer\">list of exceptions<\/a> to the penalty. However, you will still be required to pay ordinary income tax on the amount withdrawn.<\/p>\n<h3 class=\"wp-block-heading\">Traditional IRA Investment Options<\/h3>\n<p><strong>Self-Directed Investing.<\/strong> One of the biggest advantages of an IRA \u2013 traditional or Roth \u2013 is that you have complete control over the account. That means you can create your own portfolio, choose the investments that make it up, and buy and sell securities on your own timetable.<\/p>\n<p><strong>Account Trustee.<\/strong> You\u2019re free to choose any trustee platform you want. <strong>You can choose any of the following trustees to hold the plan:<\/strong><\/p>\n<ul>\n<li>A <a href=\"https:\/\/www.goodfinancialcents.com\/best-national-banks\/\" data-wpel-link=\"internal\" rel=\"noopener\">Bank<\/a>, Particularly an Online Bank Paying High-Interest Rates<\/li>\n<\/ul>\n<ul>\n<li>Investment Brokerages, Like <a href=\"https:\/\/www.goodfinancialcents.com\/etrade-review-best-for-active-traders\/\" target=\"_blank\" rel=\"noreferrer noopener\" data-wpel-link=\"internal\">E*TRADE<\/a><\/li>\n<\/ul>\n<ul>\n<li>Managed Funds or Investment Accounts<\/li>\n<\/ul>\n<ul>\n<li><a href=\"https:\/\/www.goodfinancialcents.com\/etf-vs-mutual-funds\/\" data-wpel-link=\"internal\" rel=\"noopener\">Mutual Fund or Exchange-Traded Funds (ETF)<\/a> Families<\/li>\n<\/ul>\n<ul>\n<li><a href=\"https:\/\/www.goodfinancialcents.com\/best-robo-advisors\/\" data-wpel-link=\"internal\" rel=\"noopener\">Robo-Advisors<\/a>, Like <a href=\"https:\/\/secure.goodfinancialcents.com\/branded\/splash?company_alias=betterment-iras&amp;pcuid=u4473a4def68&amp;redirect_to_top=1&amp;skip_dynamic_offer=true&amp;vertical_alias=iras\" data-wpel-link=\"external\" rel=\"external noopener noreferrer\">Betterment<\/a>, <a href=\"https:\/\/www.goodfinancialcents.com\/wealthfront-review\/\" data-wpel-link=\"internal\" rel=\"noopener\">Wealthfront<\/a>, or <a href=\"https:\/\/www.goodfinancialcents.com\/ally-invest-review\/\" data-wpel-link=\"internal\" rel=\"noopener\">Ally Invest<\/a><\/li>\n<\/ul>\n<ul>\n<li><a href=\"https:\/\/www.goodfinancialcents.com\/peer-to-peer-lending\/\" data-wpel-link=\"internal\" rel=\"noopener\">Peer-to-peer Lending Platforms<\/a>, Like <a href=\"https:\/\/www.goodfinancialcents.com\/lending-club-review-for-investors-and-borrowers\/\" data-wpel-link=\"internal\" rel=\"noopener\">Lending Club<\/a> or <a href=\"https:\/\/www.goodfinancialcents.com\/prosper-loans\/\" data-wpel-link=\"internal\" rel=\"noopener\">Prosper<\/a><\/li>\n<\/ul>\n<ul>\n<li>A <a href=\"https:\/\/www.goodfinancialcents.com\/how-to-invest-reit\/\" data-wpel-link=\"internal\" rel=\"noopener\">Real Estate Investment Trust (REIT)<\/a><\/li>\n<\/ul>\n<ul>\n<li><a href=\"https:\/\/www.goodfinancialcents.com\/best-crowdfunding-platforms\/\" data-wpel-link=\"internal\" rel=\"noopener\">Crowdfunding Platforms<\/a> Like Peerstreet, <a href=\"https:\/\/www.goodfinancialcents.com\/go\/fundrise\/fundrise-alternatives\" data-wpel-link=\"internal\" rel=\"noopener\">Fundrise<\/a>, and RealtyShares<\/li>\n<\/ul>\n<p><strong>If you\u2019re looking for a Roth IRA account, check out these <a href=\"https:\/\/www.goodfinancialcents.com\/best-places-to-open-a-roth-ira\/\" target=\"_blank\" rel=\"noreferrer noopener\" data-wpel-link=\"internal\">best Roth IRA options<\/a>.\u00a0<\/strong><\/p>\n<p><strong>Investment Options.<\/strong> There\u2019s more good news here. You can hold just about any type of investment in a traditional IRA that you choose. The IRS has a very short list of prohibited investments, and they\u2019re generally not the kind you would buy anyway.<\/p>\n<p>As for what type of investments you can hold \u2013 <em><strong>just use your imagination!<\/strong><\/em> Mutual funds, <a href=\"https:\/\/www.goodfinancialcents.com\/investing-in-etfs\/\" data-wpel-link=\"internal\" rel=\"noopener\">ETFs<\/a>, <a href=\"https:\/\/www.goodfinancialcents.com\/target-date-mutual-funds-not-good-choice\/\" data-wpel-link=\"internal\" rel=\"noopener\">target date funds<\/a>, <a href=\"https:\/\/www.goodfinancialcents.com\/bonds-vs-stocks\/\" data-wpel-link=\"internal\" rel=\"noopener\">individual stocks and bonds<\/a>, <a href=\"https:\/\/www.goodfinancialcents.com\/best-cd-rates\/\" data-wpel-link=\"internal\" rel=\"noopener\">certificates of deposit<\/a>, options, gold, foreign currency, and real estate investment trusts.<\/p>\n<h4 class=\"wp-block-heading\"><strong>A traditional IRA is the virtual antidote to a 401(k) plan with limited investment options.<\/strong><\/h4>\n<h4 class=\"wp-block-heading\"><strong>How Traditional IRA Works<\/strong><\/h4>\n<figure class=\"wp-block-table\">\n<table>\n<thead>\n<tr>\n<th>Topic<\/th>\n<th>Description<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td><strong>IRA Contribution Limits<\/strong><\/td>\n<td>$6,500 per year, or $7,500 if 50 or Older<\/td>\n<\/tr>\n<tr>\n<td><strong>Spousal IRA Provision<\/strong><\/td>\n<td>Spouse Can Contribute if the Other Lacks Earned Income<\/td>\n<\/tr>\n<tr>\n<td><strong>Required Minimum Distributions (RMDs)<\/strong><\/td>\n<td>Mandatory Withdrawals Start at Age 73<\/td>\n<\/tr>\n<tr>\n<td><strong>Tax Deductibility of Traditional IRA Contributions<\/strong><\/td>\n<td>Full Deduction When Not Covered by Employer Plan<\/td>\n<\/tr>\n<tr>\n<td><strong>Investment Income Tax Deferral<\/strong><\/td>\n<td>Earnings Grow Tax-Deferred, Enhancing Savings<\/td>\n<\/tr>\n<tr>\n<td><strong>Taxability of IRA Withdrawals<\/strong><\/td>\n<td>Ordinary Income Tax After Age 59 \u00bd<\/td>\n<\/tr>\n<tr>\n<td><strong>Early Withdrawal Treatment<\/strong><\/td>\n<td>10% Penalty and Tax for Withdrawals Before 59 \u00bd<\/td>\n<\/tr>\n<tr>\n<td><strong>Traditional IRA Investment Options<\/strong><\/td>\n<td>Self-Directed With Various Trustee Choices<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/figure>\n<h2 class=\"wp-block-heading\">The Roth IRA Conversion<\/h2>\n<p>No discussion of a traditional IRA would be complete without mentioning the Roth IRA conversion. The conversion is available for both IRA and 401(k) plans. But it\u2019s generally easier to do it with an IRA since it\u2019s a completely self-directed plan. <\/p>\n<p>While some employers do permit IRA conversions while you\u2019re still employed, most will require that you remain in the 401(k) until your employment is terminated.<\/p>\n<p><strong>Why Do a Roth IRA Conversion? <\/strong>The Roth IRA has the lone distinction (along with the Roth 401(k), Roth 403(b), etc.) of providing tax-free income in retirement. It works much like a traditional IRA in that income within the plan is tax-deferred. It also has the same contribution limits.<\/p>\n<p>But contributions to a Roth IRA are not tax-deductible. However, when you turn 59 \u00bd, and if you have been in the plan for a minimum of five years, distributions can be taken tax-free. That includes distributions of both your contributions and your investment earnings.<\/p>\n<p>One of the big advantages of a Roth IRA conversion is that there\u2019s no limit on the amount of retirement money you can convert to a Roth. <\/p>\n<p>You can build up the Roth account much more quickly by doing a conversion of, say, $100,000 from an IRA or 401(k), than by annual contributions of $6,000.<\/p>\n<p>This is why Roth IRAs and Roth IRA conversions from other retirement plans, have become so popular.<\/p>\n<h3 class=\"wp-block-heading\">The Tax Implications of a Roth Conversion<\/h3>\n<p>The downside of the conversion is that you will pay tax on the amount converted. The good news is there is no early withdrawal penalty, even if the conversion takes place before 59 \u00bd.<\/p>\n<p>Let\u2019s say you\u2019re in the 22% federal income tax bracket. You convert $100,000 from a traditional IRA to a Roth IRA. You\u2019ll pay $22,000 \u2013 $100,000 X 22% \u2013 in the year you do the conversion. <\/p>\n<p>But once you do, and you meet the Roth IRA age and plan length requirements, you can begin taking distributions tax-free.<\/p>\n<p>This is the summary version of a Roth IRA conversion. I go much deeper into the topic of my Roth IRA conversion article.<\/p>\n<h2 class=\"wp-block-heading\">How the 401(k) Works<\/h2>\n<p><strong>Here are the basics of the 401(k):<\/strong><\/p>\n<h3 class=\"wp-block-heading\">401(k) Contributions<\/h3>\n<p><strong><a href=\"https:\/\/www.goodfinancialcents.com\/401k-contribution-limits\/\" data-wpel-link=\"internal\" rel=\"noopener\">401(k) Contribution Limits<\/a>.<\/strong> <a href=\"https:\/\/www.irs.gov\/newsroom\/401k-limit-increases-to-22500-for-2023-ira-limit-rises-to-6500\" data-wpel-link=\"external\" rel=\"external noopener noreferrer\">For 2023, the 401(k) contribution limit is $22,500<\/a>, up $2000 from $20,500 in 2022. The catch-up contribution is now $7,500, also up $1000 from 2022. That means if you\u2019re 50 or older, your contribution can be as high as $30,000 for the year.<\/p>\n<p><strong>Employer Matching Contribution.<\/strong> Many employers, particularly large ones, offer some sort of matching contribution. For example, if they offer a 50% match, and you make a 10% contribution, the total contribution will be 15%.<\/p>\n<p>According to the Society for Human Resource Management (SHRM), <a href=\"https:\/\/www.shrm.org\/resourcesandtools\/hr-topics\/benefits\/pages\/bigger-401k-matches.aspx\" data-wpel-link=\"external\" rel=\"external noopener noreferrer\">42% of companies match dollar-for-dollar on 401(k) contributions<\/a>. If you make a 10% contribution, and your company will match 100%, your total contribution will be 20%.<\/p>\n<p>Employer matching contributions are subject to vesting provisions. Vesting refers to the time it takes before the employer match is considered to be permanently yours. <\/p>\n<p>Depending on the vesting schedule used, it can take anywhere from two years to six years before you become 100% vested in the employer match.<\/p>\n<p>In theory, combined contributions to a 401(k) plan from you and your employer can be as high as $66,000 for 2023, up $5,000 from last year (or $73,500 if you\u2019re 50 or older).<\/p>\n<p><strong>401(k) Funding Method.<\/strong> One of the big advantages of a 401(k) plan is the ease of funding it. Since it\u2019s employer-sponsored, your contributions are made by automatic payroll deductions. <\/p>\n<p>This is one of the simplest ways to fund any investment program, making it an easy path to <a href=\"https:\/\/www.goodfinancialcents.com\/successful-investing-building-wealth\/\" data-wpel-link=\"internal\" rel=\"noopener\">wealth building<\/a>. All you need to do is select your contribution percentage and let the contributions flow into your account. <\/p>\n<p>If your employer offers a matching contribution, it will generally be made as your contributions are.<\/p>\n<h3 class=\"wp-block-heading\">Tax Deductibility of 401(k) Contributions<\/h3>\n<p>Your contributions to a 401(k) plan are fully tax-deductible. What\u2019s more, employer matching contributions are not taxable in the year received. Given the amount of contributions permitted under the plan, this can result in a substantial <a href=\"https:\/\/www.goodfinancialcents.com\/best-tax-software-programs\/\" data-wpel-link=\"internal\" rel=\"noopener\">tax deduction<\/a>.<\/p>\n<p><strong>Tax Deferral of Investment Earnings.<\/strong> Just as is the case with the IRA and virtually every other tax-sheltered retirement plan, investment earnings accumulate within the plan on a <a href=\"https:\/\/www.goodfinancialcents.com\/ask-gfc-005-do-tax-deferred-accounts-make-sense-if-tax-rates-will-be-higher\/\" data-wpel-link=\"internal\" rel=\"noopener\">tax-deferred basis<\/a>. That means you can invest without regard to income tax consequences. <\/p>\n<p>This is a powerful compounding advantage since a 10% return on investment will actually be 10%. It won\u2019t be reduced down to 7% if you\u2019re in a 30% marginal tax bracket, as would be the case with a taxable investment.<\/p>\n<p><strong>Taxability of 401(k) Withdrawals. <\/strong>Neither your plan contributions nor the investment earnings on the plan are taxable during the accumulation phase. You\u2019re eligible to begin making withdrawals from the plan after turning 59 \u00bd. <\/p>\n<p>Ordinary income tax must be paid on the distributions, which will include both contributions and investment earnings.<\/p>\n<p><strong>Early 401(k) Withdrawals. <\/strong>If you take distributions from a 401(k) plan before reaching age 59 \u00bd, you will not only have to pay ordinary income tax but also a 10% early withdrawal penalty. <\/p>\n<p>But as is the case with IRAs, the IRS has a fairly long list of exceptions to the early withdrawal penalty. However, you will still have to pay ordinary income tax on the amount withdrawn.<\/p>\n<h3 class=\"wp-block-heading\">Other 401(k) Plan Features<\/h3>\n<p><strong>401(k) Plan Investment Options.<\/strong> Generally speaking, your options will be limited to those selected by your employer. The employer will choose the account trustee and often the investments that will be available for the plan. <\/p>\n<p>For example, the employer can have the plan administered by a mutual fund company, which would limit your investments to the funds offered by that company. In more liberal plans, the trustee may be a diversified investment broker. <\/p>\n<p>If that\u2019s the case, you may have investment options similar to those offered in a self-directed IRA.<\/p>\n<p>Yet another disadvantage of an employer-sponsored plan is fees. There will generally be an annual fee charged by the plan administrator. You may also be locked in certain other fees, such as mutual fund load fees.<\/p>\n<p>As a participant in the plan, your options will be limited to the fees charged and investments available within the trustee program.<\/p>\n<p><strong>401(k) Loan Privileges.<\/strong> This is a benefit available for 401(k) plans that can\u2019t be done with an IRA. <a href=\"https:\/\/www.goodfinancialcents.com\/mortgages-and-loans\/\" data-wpel-link=\"internal\" rel=\"noopener\">Loans<\/a> are permitted under IRS guidelines, though not all employers offer them.<\/p>\n<p><strong>Under IRS regulations, you can borrow up to the <em>lesser of<\/em>:<\/strong><\/p>\n<p>1. The greater of $10,000 or 50% of your vested account balance, OR<\/p>\n<\/p>\n<p>2. $50,000<\/p>\n<p>Now, it\u2019s important to understand that the amount you can borrow from the plan is based on the vested balance, not the total balance. <\/p>\n<p>For example, if your plan has $50,000, which includes $20,000 in investment earnings, $20,000 in contributions by you, and $10,000 in non-vested contributions by your employer, your base for calculating the loan amount will be $40,000. <\/p>\n<p>Since you can borrow 50% of this amount, the maximum loan will be $20,000.<\/p>\n<h3 class=\"wp-block-heading\">Required Minimum Distributions (RMDs) on a 401(k)<\/h3>\n<p>As you might expect, these are required on 401(k) plans, just as they are on traditional IRAs. You must begin taking distributions no later than age 73. <\/p>\n<p>The distributions are based on your remaining life expectancy, which means the percentage distributed will increase slightly each year as you age.<\/p>\n<h3 class=\"wp-block-heading\">Your 401(k) Plan May Offer a Roth 401(k)<\/h3>\n<p>An increasing number of 401(k) plans are now offering a Roth 401(k) option. This has become especially common among large employers.<\/p>\n<p>What makes a Roth 401(k) provision especially attractive is that it offers much higher contribution limits than a Roth IRA. For example, the maximum you can contribute to a Roth 401(k) is the maximum that you can contribute to any 401(k).<\/p>\n<p>Alternatively, you can split the contribution between the traditional and Roth portions of your 401(k).<\/p>\n<p>This will probably be well advised. Just as is the case with a Roth IRA, contributions to a Roth 401(k) are not tax-deductible. If you contribute the full amount to the Roth portion of your 401(k), you won\u2019t get any help on the tax side. That can cause a serious budget squeeze.<\/p>\n<p>The withdrawal provisions for the Roth 401(k) are similar to a Roth IRA. You can begin taking penalty-free withdrawals from the plan once you reach age 59 \u00bd and have been in the plan for a minimum of five years.<\/p>\n<p>If you participate in a Roth 401(k), the employer will carry separate balances for both the traditional and Roth portion of the plan.<\/p>\n<p>What\u2019s more, any employer-matching contributions on the Roth portion must be deposited into the traditional portion. This is to maintain the separation between pretax contributions (the employer match) and actual Roth contributions (your contributions).<\/p>\n<div class=\"wp-block-gfc-custom-blocks-gfc-blue-callout-box-no-button-block container gfc-blue-callout-box-no-button-blockwrap gfc-blockwrap blue-callout-box-no-button-wrapper undefined wide\">\n<div class=\"row\">\n<div class=\"col-md-12 d-flex align-items-center justify-content-undefined\">\n<div class=\"blue-callout-box-no-button-wrapper\">\n<p class=\"blue-callout-box-no-button-message\">The net result is that the employer contributions residing on the traditional side of your plan will be taxable on distribution. The Roth distributions will not be taxable.<\/p>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n<h3 class=\"wp-block-heading\">Other Roth 401(k) Features<\/h3>\n<p><strong>Roth IRA Conversion of the Roth 401(K).<\/strong> This is a real sweet spot because you can roll a Roth 401(k) over to a Roth IRA without tax consequences. This is because the Roth IRA and Roth 401(k) are equivalent plans from a tax standpoint.<\/p>\n<p><strong>Roth 401(k) RMD rules.<\/strong> Unlike a Roth IRA, a <a href=\"https:\/\/www.irs.gov\/retirement-plans\/retirement-plans-faqs-regarding-required-minimum-distributions#2\" target=\"_blank\" rel=\"noreferrer noopener external\" data-wpel-link=\"external\">Roth 401(k) <em>is<\/em> subject to RMDs beginning at age 73<\/a>. However, this won\u2019t affect your tax situation since those distributions will be tax-free anyway. The only negative is that <a href=\"https:\/\/www.goodfinancialcents.com\/required-minimum-distribution-rules-ira-401ks\/\" data-wpel-link=\"internal\" rel=\"noopener\">RMDs<\/a> will deplete the account, reducing future account growth.<\/p>\n<h4 class=\"wp-block-heading\">How the 401(k) Works<\/h4>\n<figure class=\"wp-block-table\">\n<table>\n<thead>\n<tr>\n<th>Topic<\/th>\n<th>Description<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td><strong>401(k) Contributions<\/strong><\/td>\n<td>\u2022 Max $22,500 (or $30,000 if 50 or Older) in 2023 <br \/>\u2022 Employer Matching Contributions Often Available <br \/>\u2022 Vesting Rules Apply for Employer Contributions<\/td>\n<\/tr>\n<tr>\n<td><strong>401(k) Funding Method<\/strong><\/td>\n<td>\u2022 Contributions Through Automatic Payroll Deductions<\/td>\n<\/tr>\n<tr>\n<td><strong>Tax Deductibility of 401(k) Contributions<\/strong><\/td>\n<td>\u2022 Contributions Are Fully Tax-Deductible<\/td>\n<\/tr>\n<tr>\n<td><strong>Tax Deferral of Investment Earnings<\/strong><\/td>\n<td>\u2022 Investment Earnings Grow Tax-Deferred, Enhancing Returns<\/td>\n<\/tr>\n<tr>\n<td><strong>Taxability of 401(k) Withdrawals<\/strong><\/td>\n<td>\u2022 Ordinary Income Tax After Age 59 \u00bd<\/td>\n<\/tr>\n<tr>\n<td><strong>Early 401(k) Withdrawals<\/strong><\/td>\n<td>\u2022 10% Penalty and Income Tax for Withdrawals Before 59 \u00bd<\/td>\n<\/tr>\n<tr>\n<td><strong>401(k) Plan Investment Options<\/strong><\/td>\n<td>\u2022 Limited to Employer-Selected Options and Trustees<\/td>\n<\/tr>\n<tr>\n<td><strong>401(k) Loan Privileges<\/strong><\/td>\n<td>\u2022 Loans Allowed Up to Certain Limits<\/td>\n<\/tr>\n<tr>\n<td><strong>Required Minimum Distributions (RMDs)<\/strong><\/td>\n<td>\u2022 Mandatory Withdrawals Start at Age 73<\/td>\n<\/tr>\n<tr>\n<td><strong>Roth 401(k) Option<\/strong><\/td>\n<td>\u2022 Higher Contribution Limits, Tax-Free Withdrawals Later <br \/>\u2022 Separate From Traditional 401(k), Possible Roth IRA Rollover<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/figure>\n<h2 class=\"wp-block-heading\">The Traditional IRA vs. The 401(k) Plan \u2013 The Advantages of Each<\/h2>\n<p><strong>Comparing the two programs side-by-side, here\u2019s a summary of the advantages each provides.<\/strong><\/p>\n<p><strong>IRA:<\/strong><\/p>\n<ul>\n<li>You choose the plan trustee.<\/li>\n<\/ul>\n<ul>\n<li>Self-Directed Investing \u2013 you can invest in anything you choose or even choose a third-party investment management option.<\/li>\n<\/ul>\n<ul>\n<li>You can set up a Spousal IRA for a nonworking spouse.<\/li>\n<\/ul>\n<ul>\n<li>Traditional IRAs are easier to do a Roth IRA conversion with since you have full control over the account.<\/li>\n<\/ul>\n<p><strong>401(k):<\/strong><\/p>\n<ul>\n<li>Very high contribution limit.<\/li>\n<\/ul>\n<ul>\n<li>Employer matching contributions, making your total annual contribution even higher.<\/li>\n<\/ul>\n<ul>\n<li>Ease of contributions through automatic payroll deductions.<\/li>\n<\/ul>\n<ul>\n<li>401(k) loan provision.<\/li>\n<\/ul>\n<ul>\n<li>Your 401(k) may come with a Roth 401(k) provision.<\/li>\n<\/ul>\n<h2 class=\"wp-block-heading\">Why You Should <em>Seriously<\/em> Consider Having Both an IRA and a 401(k)<\/h2>\n<figure class=\"wp-block-embed is-type-video is-provider-youtube wp-block-embed-youtube wp-embed-aspect-16-9 wp-has-aspect-ratio\">\n<div class=\"wp-block-embed__wrapper\">\n<p><iframe loading=\"lazy\" title=\"Roth IRA vs. 401(k): How to Choose | NerdWallet\" width=\"640\" height=\"360\" src=\"https:\/\/www.youtube.com\/embed\/5GS4WMN4PlA?feature=oembed\" frameborder=\"0\" allow=\"accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture; web-share\" allowfullscreen><\/iframe><\/p>\n<\/div>\n<\/figure>\n<p>Remember at the beginning, I said this really isn\u2019t about the traditional IRA vs. the 401(k) plan? Let\u2019s spend some more time on that point.<\/p>\n<blockquote class=\"wp-block-quote\">\n<p>If you can \u2013 <em><strong>and you usually can<\/strong><\/em> \u2013 you should have both plans going at the same time. Each provides its own unique set of benefits. But when you put the two together, you gain the advantages of both plans.<\/p>\n<\/blockquote>\n<p>From the IRA, you get the benefit of completely self-directed investing, including using any investments you want. This isn\u2019t typically available in 401(k) plans. You can also add your spouse to your IRA plan through a spousal IRA.<\/p>\n<p>But from the 401(k) plan, you gain higher contributions (and a larger tax deduction!), as well as the benefit of an employer-matching contribution. There may even be a Roth 401(k) provision, which is always worth having. Then there\u2019s the 401(k) loan option.<\/p>\n<p>But perhaps the biggest reason to have both plans is the benefit of higher contributions.<\/p>\n<p>If you\u2019re able to make the full $22,500 401(k) contribution and you add a $7,500 IRA contribution, your total retirement contribution will be $22,500 (or $30,000 if you\u2019re 50 or older). <\/p>\n<p>With that kind of money flowing into your retirement plans each and every year, you\u2019ll be a multimillionaire by the time you reach 65. Let that sink in. As contribution limits grow, so should your contributions. <\/p>\n<p>As I said earlier, those increased amounts can make a major difference over the span of a few decades.<\/p>\n<p>And maybe even more exciting is the prospect of early retirement. Start using dual retirement plans in your 20s or 30s, and you\u2019ll be retired long before you turn 50.<\/p>\n<p><strong>There are two other situations where combining a traditional IRA and 401(k) is almost a requirement:\u00a0<\/strong><\/p>\n<ul>\n<li>The traditional IRA contribution will be fully tax-deductible and\/or<\/li>\n<\/ul>\n<ul>\n<li>When you have no employer-matching contribution.<\/li>\n<\/ul>\n<div class=\"wp-block-gfc-custom-blocks-gfc-blue-callout-box-no-button-block container gfc-blue-callout-box-no-button-blockwrap gfc-blockwrap blue-callout-box-no-button-wrapper undefined wide\">\n<div class=\"row\">\n<div class=\"col-md-12 d-flex align-items-center justify-content-undefined\">\n<div class=\"blue-callout-box-no-button-wrapper\">\n<p class=\"blue-callout-box-no-button-message\">If anyone asks,\u00a0<strong><em>\u201ctraditional IRA or 401(k)?\u201d<\/em>\u00a0<\/strong>the answer is\u00a0<em><strong>\u201cboth\u201d<\/strong><\/em>\u00a0if you can make it happen.<\/p>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n<h2 class=\"wp-block-heading\">The Bottom Line \u2013 Traditional IRA vs. 401(k) Plan \u2013 Which Plan Wins?<\/h2>\n<p>In weighing the pros and cons between a Traditional IRA and a 401(k) plan, it\u2019s apparent that each serves unique financial and <a href=\"https:\/\/www.goodfinancialcents.com\/retirement-planning-checklist\/\" data-wpel-link=\"internal\" rel=\"noopener\">retirement planning needs<\/a>. <\/p>\n<p>While a 401(k) may offer a higher contribution limit and the perk of employer matching, its investment options can be restrictive and bound to the choices provided by the employer. <\/p>\n<p>On the other hand, a Traditional IRA provides a platform for more diversified investment choices alongside some tax-deductibility features. <\/p>\n<p>Moreover, the tax-deferred growth in both plans enhances the compounding effect, which is crucial for long-term growth. <\/p>\n<p>Engaging in both plans could provide a balanced approach, allowing individuals to maximize employer contributions, enjoy tax advantages, and access a broader investment horizon. <\/p>\n<div class=\"wp-block-uagb-inline-notice uagb-inline_notice__align-left uagb-block-099b5386\">\n<h4 class=\"uagb-notice-title\">Therefore:<\/h4>\n<div class=\"uagb-notice-text\">A diversified strategy, incorporating both Traditional IRA and 401(k) plans, may provide a more robust foundation for achieving retirement financial goals, catering to individual preferences and the varying degrees of investment freedom they offer.<\/div>\n<\/div>\n<div class=\"wp-block-gfc-custom-blocks-gfc-get-started-link-block gfc-get-started-link-blockwrap gfc-blockwrap container get-started-link-wrapper undefined wide\">\n<div class=\"row\">\n<div class=\"col-md-12 d-flex align-items-center justify-content-undefined\">\n<div class=\"get-started-link-wrapper\"><a href=\"https:\/\/www.goodfinancialcents.com\/best-places-to-open-a-roth-ira\/\" class=\"get-started-link\" target=\"_blank\" rel=\"noopener noreferrer\" data-wpel-link=\"internal\">Best Places To Open A Roth IRA<\/a><\/div>\n<\/div>\n<\/div>\n<\/div>\n<p>The post <a rel=\"nofollow noopener\" href=\"https:\/\/www.goodfinancialcents.com\/traditional-ira-vs-401k-plan\/\" data-wpel-link=\"internal\">Traditional IRA vs. 401(k) Plan \u2013 Which Plan Wins?<\/a> appeared first on <a rel=\"nofollow noopener\" href=\"https:\/\/www.goodfinancialcents.com\" data-wpel-link=\"internal\">Good Financial Cents\u00ae<\/a>.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Financial bloggers often portray the traditional IRA vs. the 401(k) plan as a debate, as&#8230;<\/p>\n","protected":false},"author":1,"featured_media":237,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[11],"tags":[],"_links":{"self":[{"href":"http:\/\/marshalllodge.co.uk\/index.php\/wp-json\/wp\/v2\/posts\/409"}],"collection":[{"href":"http:\/\/marshalllodge.co.uk\/index.php\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/marshalllodge.co.uk\/index.php\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/marshalllodge.co.uk\/index.php\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"http:\/\/marshalllodge.co.uk\/index.php\/wp-json\/wp\/v2\/comments?post=409"}],"version-history":[{"count":1,"href":"http:\/\/marshalllodge.co.uk\/index.php\/wp-json\/wp\/v2\/posts\/409\/revisions"}],"predecessor-version":[{"id":410,"href":"http:\/\/marshalllodge.co.uk\/index.php\/wp-json\/wp\/v2\/posts\/409\/revisions\/410"}],"wp:featuredmedia":[{"embeddable":true,"href":"http:\/\/marshalllodge.co.uk\/index.php\/wp-json\/wp\/v2\/media\/237"}],"wp:attachment":[{"href":"http:\/\/marshalllodge.co.uk\/index.php\/wp-json\/wp\/v2\/media?parent=409"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/marshalllodge.co.uk\/index.php\/wp-json\/wp\/v2\/categories?post=409"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/marshalllodge.co.uk\/index.php\/wp-json\/wp\/v2\/tags?post=409"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}