Every hard-working American dreams of retiring someday. We imagine what life will be like: where we’ll live, what we’ll do, where we’ll go on vacation. But all those dreams come with a reality – money.
Money is essential for fulfilling our retirement bucket list – and all the everyday, cost-of-living expenses too, including house, health, food, and utilities. That means getting serious about saving way, way in advance.
When it comes to saving for retirement, two of the most popular options are individual retirement accounts (IRAs) and 401(k)s. Both offer tax-advantaged ways to save for your golden years, but there are some key differences between the two. Let’s explore an IRA versus a 401k and talk about some helpful tax benefits too.
IRA vs 401K
What Is an IRA?
An IRA is a retirement savings account that individuals can open on their own. They are typically opened at a brokerage firm, a bank, or a credit union and can be funded with pre-tax or after-tax dollars.
There are two main types of IRAs: traditional and Roth. With a traditional IRA, contributions are tax-deductible, but withdrawals in retirement are taxed as ordinary income. With a Roth IRA, contributions are made with after-tax dollars, but withdrawals in retirement are tax-free.
What Is a 401k?
A 401(k) is a retirement savings plan typically offered by an employer. Like a traditional IRA, contributions to a 401(k) are made with pre-tax dollars, which reduces your taxable income in the year you make the contribution. In addition, many employers offer a matching contribution, which is essentially free money that you can put toward your retirement savings.
What’s the Difference Between an IRA and a 401k?
One of the biggest differences between IRAs and 401(k)s is the contribution limits. In 2023, the maximum contribution limit for a traditional or Roth IRA is increasing to $6,500 per year ($7,500 if you’re age 50 or older). For a 401(k), the maximum contribution limit is $22,500 per year ($30,000 if you’re age 50 or older).
Another key difference is the investment options. With an IRA, you have complete control over how your money is invested. You can choose from a wide variety of stocks, bonds, mutual funds, and other investments. With a 401(k), your investment options are limited to the choices offered by your employer. While many employers offer a diverse range of investment options, you may be limited in your ability to customize your portfolio.
There are more options than just traditional and Roth IRAs, however. Police FCU offers several choices for our members:
A great option for creating a balanced, long-term savings plan with tax-deferred earnings and possible tax-deductible contributions.
This offers more flexibility in the use of your investment. While not tax deductible, qualified distributions are tax-free. (You should consult your tax advisor about maximizing this option.)
SEP (Simplified Employee Pension) IRA
This is a retirement account that allows employers to make tax-deductible contributions on behalf of eligible employees. Employees do not pay tax on these contributions, but distributions are taxed subject to many traditional IRA rules.
Coverdell Education Savings Accounts
This option can be used to pay for qualified elementary and secondary education expenses (tuition, fees, books, other supplies – in some cases, even room and board).
Contributions are not tax-deductible, but a Coverdell ESA offers the potential for tax-free withdrawals if they are used to pay qualified education expenses. In order to get the maximum benefit, you should make regular contributions.
Benefits of Police FCU IRA Accounts
Besides easily saving for your future retirement, our IRA options come with additional perks:
- No account opening or maintenance fees
- No transfer fees and premium rates
- Additional options like IRA Shares and IRA Share Certificates of Deposit (CDs)
- An easy rollover process with available support from our specialists.
A Police FCU IRA is also a great place to reinvest your 401(k), Qualified Retirement Account, or a rollover. A rollover is when you move assets from an employer-sponsored retirement plan (like a 401k or 403b) into an IRA account.
What Are Some IRA Tax Benefits?
One of the biggest advantages of an IRA is the tax benefits. With a traditional IRA, contributions are tax-deductible, which means that you can reduce your taxable income by the amount of your contribution.
For example, if you contribute $6,500 to a traditional IRA in 2023 and your income is $65,000, your taxable income will be reduced to $54,000.
In addition, your contributions and earnings will grow tax-deferred, which means that you won’t pay taxes on them until you make withdrawals in retirement.
With a Roth IRA, contributions are made with after-tax dollars, which means that you won’t get a tax deduction in the year you make the contribution.
Your contributions and earnings grow tax-free, however, which means that you won’t have to pay taxes on them when you make withdrawals in retirement. This can be a huge advantage if you expect to be in a higher tax bracket in retirement than you are currently.
Another benefit of IRAs is that they offer more flexibility than 401(k)s. With a Roth IRA, you can withdraw your contributions before retirement (or age 59 ½) without taxes and penalties. However, taxes and penalities apply to withdrawals that include earnings.
There are some exceptions to the earnings penalties (but not the taxes) for situations like a disability, buying your first home, or an adoption.
In addition, if you contribute and withdraw within the same tax year, the contribution is treated as if it never happened, so it’s exempt from penalties. (However, you will have to report the earnings as investment income.)
With a 401(k) (or traditional IRAs), withdrawals before retirement (or age 59 ½) usually come with penalties. These penalties include federal income tax, relevant state taxes, and a 10% additional IRS penalty. There are exceptional circumstances where the 10% penalty may be waived called hardship distributions, but these are rare.
What About Help Paying for Taxes Now?
Tax season is upon us, and if you find yourself in a situation where you’re looking at owing an amount you can’t afford right now, we have some solutions for you.
Police FCU offers several personal loan options that can give you the cash you need now at a lower interest rate than a high-interest credit card or payday loan.
See all our personal loan options and apply for the one that works best for you.
In addition, Police FCU is offering a 13-month IRA Share Certificate Special with a 4.00% APY.