How to Compare a 401k to an IRA

First-time investors and young professionals often consider a 401k and an individual retirement account (IRA) interchangeable. These 2 retirement vehicles are vastly different in terms of long-term accumulation, tax status and other criteria. You need to compare a potential 401k and IRA before investing money to get the best return.

Difficulty: Moderately Easy

Instructions

Things You'll Need:

• Prospectus for company 401k and IRA

1. Choose a retirement plan based on the tax status of contributions to your account. You can avoid income taxes on your account's principal with after-tax deferrals to a IRA. The traditional 401k provides a short-term tax benefit, but you have to pay income taxes on the principal upon withdrawal.

2. Review the tax benefits on investment returns and accumulations for a 401k and an IRA. The 401k does not require any federal tax payments, but some states require small taxes on returns upon withdrawal. Your use of an IRA involves no taxation on the state or federal level for your returns.

3. Search through the withdrawal policies of an IRA and a 401k to compare both accounts accurately. Individual retirement accounts accrue no penalties for withdrawals as long as you have maintained the account for at least 5 years. There are restrictions on withdrawing money from a 401k before retirement.

4. Assess the amount of employer contribution for a 401k and an IRA to compare the value of each as a retirement vehicle. The upper contribution limits are the same for employees, but employers are held to a different limit for a 401k and an IRA.

5. Determine the possible use of both accounts as a lending tool before you make your first investment. You cannot use an IRA for loans in case of hardship, but 401k regulations allow you to loan yourself money that can be repaid through each paycheck over several years.

6. Contrast the income and age limits of retirement accounts before you make a commitment. Federal laws require that 401k users have at least 1 year of service in the same company. Employer-sponsored IRAs can be activated for any employee that has made $5,000 during the last 2 years and has a significant chance of making the same amount in the next fiscal year.

Tips & Warnings

• Begin any analysis of a 401k and an IRA with an analysis of their rate of returns. The average 401k provider will give you a prospectus with average rates of return on various investment options. The IRA is simplified and acts more like a savings account than an investment fund in terms of annual returns.