The terms 401(k) and IRA regularly surface on the internet and other media now that the American society is more concerned about securing their future in an uncertain environment. One can no longer assume their jobs are permanent and will pay for a decent life after retirement because in reality, because layoffs are rather common these days. It is only sensible to start saving from an early age in the hope of accumulating enough wealth to guarantee a decent standard of living once we hit 60 years of age.
There are a variety of financial tools that help one plan for retirement and this article briefly covers one of them – the IRA.
What is an IRA?
The IRA is an Individual Retirement Account that, as the name suggests, help you save for the future, similar to the 401(k) retirement account that I covered recently. Money stored in an IRA may be tax-deferred, and grows over the years through capital gains so upon retirement, you have a decent amount of savings waiting for you in your account.
But beware that if you happen to withdraw the funds before your retire (the age of 59.5 years is considered acceptable here) then you are likely to face a 10% penalty. This condition applies to all types of 401(k) and IRA accounts, including the Roth IRA and Roth 401(k).
Differences between 401(k) and IRA
There are plenty of technical differences between these two types of retirement accounts but the three most distinct differences that this blog post covers are as follows:
- The 401(k) is setup by employers for their workers, while the IRA is a voluntary account setup by individuals. An exception is made in the case of SIMPLE IRA as well as SEP IRA, which are offered by employers.
- It only makes sense that the feature of ‘matching contributions by employers’ is only possible in the 401(k), because the IRA is a solitary arrangement.
- If you ever fall short on cash, you may take out a loan from your 401(k) account and return it with interest, but this option is not available to IRA owners (unless you are using the money to buy your first home).
Why should I store money in an IRA if I can simply open a normal savings account?
You may be tempted to simply opt for a regular savings account without the restrictions that come with an IRA. In a typical savings account, your money adds up over time and you can move money out of the account whenever you want, without the 10% early-withdrawal penalty that comes with IRAs (unless you are dealing with term deposits).
The reason it is sometimes better to go for an IRA is because if you were ever faced with bankruptcy, your IRA funds would be untouchable, up until the value of $1,000,000. That is a huge safety-feature of these accounts.
Fehmeen is a financial writer who enjoys exploring different aspects of the debt-ridden economy in an attempt to help people make informed decisions. Any ideas shared in the article should merely be considered general information instead of financial advice.