As a Certified Financial Planner®, one of the most common questions I get asked is how I save for my own retirement. I won't get into the actual stocks and funds I own in this article, but I will say that my preferred retirement savings vehicle is an individual retirement account (IRA), as opposed to a 401(k). Here's why.
Without question, the No. 1 reason I prefer an IRA to a 401(k) as a retirement savings vehicle is the investment flexibility. When you enroll in an employer's 401(k) plan, you're generally given a "menu" of investment funds to choose from -- usually a few dozen at most.
While some 401(k) plans offer excellent index funds and mutual funds, my IRA allows me to invest in virtually any stock, bonds, exchange-traded funds (ETFs), or mutual funds I want. I can buy certificates of deposit (CDs) to take advantage of high interest rates. I can even use some options strategies to generate income.
To be sure, not all of these are appropriate for all investors. For example, it's best to avoid options unless you really know what you're doing. The point is that you have much more freedom to design the retirement portfolio that you want.
And if you don't want to choose your own investments with some or all of your money, it's worth pointing out that many brokers allow IRA investors to sign up for a robo-advisor, or automated investing service. So, you could potentially put most of your retirement savings on autopilot, as with a 401(k), but also leave some that you can invest in whatever companies or funds you want.
Other IRA advantages
There are a few other benefits of IRA investing worth noting. Withdrawal flexibility is a big one.
As with a 401(k), you generally have to leave IRA investments alone until you reach 59 and one-half years of age or face an early withdrawal penalty. But there are a couple of big exceptions that apply only to IRAs:
You can withdraw up to $10,000 at any point to use toward a first-time home purchase, either for you or someone else.
You can use any amount of your IRA funds to pay for qualifying higher education expenses. In fact, it's a popular strategy to use a Roth IRA to save money for college in some cases.
Now, unless your money is in a Roth IRA, it will still be considered taxable income when withdrawn, regardless of your age. But these two early withdrawal exceptions can be very valuable to certain people.
Drawbacks of an IRA
To be fair, there are some drawbacks to using an IRA instead of a 401(k). For one thing, you can borrow from a 401(k) if you need to and then pay yourself back (with interest). There are also some exceptions that allow you to withdraw from your 401(k) before the standard retirement age if you leave your job or retire early.
Also, most employers offer a 401(k) match, so if you are eligible, it's important to take full advantage of this with your 401(k) contributions. Then and only then could it make sense to put money into an IRA. In many cases, you can contribute to and get the tax benefits of both.
The standard IRA contribution limit is also much lower than the 401(k) limit, so it might not be best if you're a retirement super-saver. For 2024, the IRA contribution limit is $7,000 for those under 50, while the 401(k) deferral limit is $23,000 for this age group. However, if you are self-employed, there are two special versions of IRAs, the SIMPLE IRA and SEP-IRA (I use the latter), that have significantly higher contribution limits. (Note: There's also a solo 401(k) for self-employed people.)
As a final thought, one key takeaway is that there's no perfect retirement account for everyone. For the reasons discussed here, my SEP-IRA does the best job of meeting my needs, but your ideal retirement account might be different.
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I Absolutely Prefer an IRA to a 401k for Retirement Savings. Here's Why. was originally published by The Motley Fool