Which Should You Do? – Contribute to an IRA or Participate in a 401(k) Plan

Ideally you should do both if you can afford it.  Having enough funds to afford the retirement lifestyle you desire is an important goal for many.  IRAs and 401(k) plans both offer a tax-advantaged way to accumulate funds.

 

Step One

In most cases, participating in a 401(k) plan should be your first choice.  Examine the terms of your plan to determine how any “employer match” may work.  In most 401(k) plans, the employer will make contributions on behalf of the participant.  It makes sense to take advantage of this employee benefit.  Your employer helps you accumulate the funds you need.  The details of plans may vary, some may provide a certain “percentage of wages” contribution and others may require the employee to contribute a certain level to get the match.  Learn the details of your plan to make sure you get the maximum match available.

 

In addition, the contributions you make to your 401(k) plan have additional tax benefits for you.  They are really deferrals of income and as such you do not pay income tax on what you defer.

 

There are IRS imposed limits on how much you may defer into your 401(k) plan.  For 2021, the maximum you may defer is $19,500.  In addition, there is now a special provision for participants age 50 and over.  You can make additional “catch-up” contributions of $6,000 for 2021.  Be sure to review your plan provisions to see how your plan is handling this feature.

 

Step Two

After contributing to your 401(k) plan, you may want to consider additional contributions to an IRA.  Depending on your level of income, contributions to an IRA may be tax deductible.  For 2021, if your adjusted gross income (AGI) is less than $66,000 and you file a single tax return, your IRA contribution is fully deductible.  If your AGI is between $66,000 and $76,000, the contribution will be partially deductible.  For individuals filing joint returns, the limits are $105,000 and $125,000 for full and partial deductibility.

 

The limit on IRA contributions for 2021 is $6,000 with further increases in later years based on inflation.  There is also a “catch-up” provision for additional contributions of up to $1,000 for workers age 50 and over for 2021.

 

Step Three

If your income level precludes you from making a tax-deductible contribution to an IRA, you may want to consider contributing to a Roth IRA.  The same contribution limits apply as for regular IRAs.  One big difference is that contributions to Roth IRAs are not tax deductible but the distributions are not subject to income tax.  The other significant difference is that Roth IRA contribution eligibility is phased out between $125,000 and $140,000 for single filers and $198,000 and $208,000 for those filing jointly for 2021.

 

Summary

Accumulating funds for a financially secure retirement should be a high priority.  Take advantage of the benefits of your 401(k) plan and then consider additional contributions to an IRA or Roth IRA.  In any case, be sure that once you make the contributions you use good judgment for the investment of the funds.  Most 401(k) plans offer a number of investment options and IRAs can have investment flexibility.  Diversification and a matching of your investments with your time horizon and risk tolerance should be part of your total retirement planning activities.