IRA versus 401(k) — Which one first?
One of the questions we get all the time is whether to contribute to your IRA or your 401(k) first. The answer isn’t as straightforward as you might think, so here’s a little background on each account type and how you might think about it.
IRA Basics
IRA stands for individual retirement account. The IRA was created to be an account that anyone has access to as an individual or a family to save for retirement by investing in just about any type of security. IRAs come in two flavors: Traditional or Roth with the key difference being whether you pay taxes on your earnings when you make the contributions (Roth) or when you withdraw (Traditional).
For example, contributions made to a Traditional IRA can be deducted from your current income for a tax break in the year you contribute to the account. Earnings on that “pre-tax” contribution grow tax-free until you withdraw — hopefully once you reach retirement age. Roth IRAs work in a similar way except contributions are made with “post-tax” money (think money from your bank account) that you don’t deduct from your current income when you do your taxes at the end of the year. Because you’ve paid your taxes up front, you don’t pay any taxes when you withdraw after you’ve reached retirement age. If you withdraw before that, you’ll pay a 10% early withdrawal penalty.
There are contribution and income limits to how much you can contribute as well. These change each year, but in 2019, the contribution limits are $6,000 per person (plus an extra $1,000 if you’re over 50), and the income limits for Roth IRAs start at $122,000 if you’re single and $193,000 if you’re married and restrict you entirely at $137,000 if you’re single and $203,000 if you’re married.
401(k) Basics
401(k)s are like the big brother to IRAs. Everything above about IRAs applies to 401(k)s except that the contribution limit is higher ($19,000 plus an extra $6,000 if you’re over 50 in 2019), there are no income limits to either Traditional or Roth contributions, and employers can make contributions to the account as well.
