If you’re a current retirement saver or you’re starting to look at your options, you may have seen articles about the ongoing debate between self-directed individual (or independent) 401(k)s and IRAs and employer-sponsored 401(k)s.
The benefit of independent 401(k) plans or IRAs is the freedom to choose your own investment options rather than the narrow set of options available through an employer-sponsored plan. The biggest benefit of an employer-sponsored 401(k) is the matching funds.
Many retirement savers choose the employer-sponsored 401(k) since it’s essentially like giving themselves a raise. Failing to maximize matching means you’re leaving money on the table.
A minority of workers with access to employer-sponsored funds choose to forego this option. They believe they can more than make up for the loss of matching funds by making wise self-directed investments. This is theoretically possible if they can beat the performance of funds available in the employer plan by more than what they lose by sacrificing matching.
While this is possible, it’s not exactly easy to accomplish or a guaranteed outcome. There are many variables that can impact the performance of individual investments, while company match is guaranteed money. The performance of company match funds will also be beholden to your 401(k) investment allocations, which could affect the long-term value of that employment benefit.
Self-Employed Options
There is a large segment of the Arizona workforce who have no choice but to invest in individual 401(k)s and IRAs because they are self-employed or don’t work at a company that offers those retirement savings benefits. These workers will need to find a DIY retirement savings solution, lobby their current employer to add a qualified plan to their compensation package or find a job where company match is available.
Contribution Limits on IRAs Versus 401(k)s
While IRAs and Roth IRAs can be extremely useful tools for some retirement savers, they do have one major disadvantage compared with 401(k)s – contribution limits. The annual contribution limit for 401(k)s in 2022 is $20,500 for workers younger than 50 and $27,000 for workers over the age of 50. The maximum combined contribution limit for your traditional IRAs and Roth IRAs is only $6,000 a year or $7,000 a year if you’re over the age of 50.
If you want to put at least 15 percent of your annual income into retirement savings, you might not be able to hit that threshold via IRAs alone.
Tax Benefits
401(k) contributions are “pre-tax” dollars, meaning they aren’t taxed and don’t count towards your taxable income. Some retirement savers may even be able to drop into a lower tax bracket with a large enough 401(k) contribution. However, 401(k) dollars will be taxed as income when they’re withdrawn.
Roth IRA dollars are the opposite. Retirement savers put after-tax dollars into a Roth IRA and then don’t have to pay tax on the growth of those investments when they make eligible withdrawals from the funds in retirement.
Some retirement savers may be able to deduct traditional IRA contributions, but those deductions are phased out if you have access to an employer-sponsored retirement plan or your income reaches certain thresholds.
Income Requirements
There are no income requirements for 401(k)s. Anyone, regardless of how much they make, can contribute to one. Conversely, you may not be eligible to put money into a Roth IRA at higher income levels. Although there’s no income threshold on traditional IRA contributions, you may not be eligible for some of its tax deductions if you’re in a higher tax bracket.
Should You Max Out the Company Match on Your 401(k)?
Every retirement saver’s situation is unique. Factors like your income, lifestyle and expenses, life expectancy, the needs of your family and your retirement goals may influence your retirement savings decisions.
These aren’t easy questions to answer, which is one of the reasons why so many retirement savers in Arizona consult with Fullerton Financial Planning. We get to know you, your situation and your retirement goals before we make customized recommendations to fit your unique needs.
Call us at (623) 974-0300 to learn more about 401(k)s, IRAs and your other retirement saving options.
