Americans have a lot of retirement savings accounts to choose from. Popular options include an individual retirement account (IRA) and a 401(k)-retirement plan.
What is an IRA (Individual Retirement Account)?
This is an account that enables everyone who has an income to put money aside for retirement on a tax-advantaged basis. When you use this retirement plan, your money can grow tax-deferred or tax-free until the day you will take it out during your retirement. Additionally, the annual contribution to this retirement plan is $6,000 in 2022 and those who are above 50 years will contribute an additional $1,000 every year.
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The two types of IRAs are:
1. Traditional account
This account enables employees to save money before taxes have been deducted from their salary. Thus, the money inside your account will grow tax-deferred until the day you will withdraw it during retirement. When you make the withdrawals, you will have to pay taxes at normal income rates. Furthermore, when you are over 72 years of age, you will be able to start taking the required minimum distributions every year.
2. Roth account
This account enables you to save for retirement after taxes have been deducted from the contributions. Therefore, although you will be taxed on your contributions, you will save your money, and withdraw it tax-free after you retire. Unlike the traditional option, you do not have to take minimum withdrawals. Moreover, you can even leave the money to your heirs tax-free. However, the Roth account has income restrictions.
What is a 401(k)?
This is a retirement plan, sponsored by an employer, which allows the employees to save cash for retirement on a tax-advantaged basis. In this account, you can choose to grow your money tax-free or tax-deferred until you withdraw it during your retirement. The yearly contribution limit to this plan in 2022 is $20,500. Employees who are fifty years old and above can contribute a catch-up of $6,500 annually.
The two types of 401(k) plans are:
Under this plan, you can save on a pre-tax basis. After you withdraw the funds, they will be taxed. When you are older than 72 years of age, you will have the option to take the required minimum distributions annually.
As an employee, you can save for your retirement using after-tax money. Moreover, the money in your account will grow on a tax-free basis, and you can withdraw it without being taxed at retirement. When you get older than 72 years, you will need to take minimum distributions.
IRA vs 401(K)
According to the financial advisers at Ubiquity, a 401k is different from an IRA in that it is more secure from creditors, you can take a loan from it and the contributions made to a traditional 401k are always tax-deductible regardless of the income you are getting. In addition, it gives employees higher contribution limits. On the other hand, individual retirement accounts are easier to obtain, require investment knowledge, and offer a better investment selection.
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In conclusion, the best retirement plan for you can include both the IRA and the 401k. When you understand the difference between the two, then you will be able to make more informed choices so you can get the highest value out of your investment choice.