I frequently field questions from people asking me to compare the use of a 401(k) account to an IRA, and I’ll discuss this a bit today.
- No income limits to make deposits
- Company may offer matching up to some level
- (Usually) limited choice of investments
- Fees may be excessive
- $15,500 deposit limit ($20,500 if 50 in 2008)
- Loans permitted at reasonable rates
- Income restrictions (single $53K-63K, joint $83K-$103K)
- No company match
- Unlimited investment choices, mostly
- Fees can be controlled, kept to a minimum
- $5000 deposit limit ($6,000 if 50 in 2008)
For those whose company matches some of their 401(k) deposit, I suggest depositing up to the match. Often, this means that for the first 5-6% of your income, you are matched 50-100%. This is worth doing almost without regard to the rest of your financial situation. Next, unless the 401(k) has truly superior choices (my company offers an S&P index fund for .05% per year. On $100,000, this is a $50/year overhead) I’d suggest going to the IRA and topping it off. As I published some time ago in my 401(k) Ripoff article, some 401(k0 custodians are charging as much as 1.4%/yr for the accounts of small employers. This expense negates much of the benefit of saving tax deferred. Unless you plan to leave an employer with such a high expense 401(k) after a brief time, I’d not deposit more than what it takes to capture the match.
One lesser known benefit of a 401(k) is that if you retire and are 55 or older on your retirement, you may take withdrawal from the account without penalty. This suggests that as you approach retirement, you might decide to pull your IRA money into that final 401(k) account to take advantage of this. Of course it depends on the balances of your various retirement accounts.
After 59-1/2, I favor moving the 401(k) accounts into an IRA as the management becomes easier. Withdrawals may be done on line, the funds moved from the IRA to your cash account, and you can write a check the same day. The choice to convert to Roth is easier, done quickly and with minimal effort. Lastly, I suggest you pay close attention to the beneficiaries on your retirement accounts. It’s too easy to forget that a first spouse is still listed, or that the current beneficiary may have predeceased you. The rules regarding IRA beneficiaries are pretty specific, and must be listed on the account. IRAs do not pass via will. Please read my April 28 post “On my Death, Please Take a Breath“. It’s a sad anecdote about what not to do when inheriting an IRA or other pre-tax retirement account.
As always, please submit a comment if you have any questions on this topic.