Woodstock Financial Advisor – Third Act Retirement Planning —

IRA vs 401K: which is best for retirement?

IRA versus 401(k), which is better for retirement? 

The first important thing to note is that there is no one size fits all answer. You can’t say that IRAs are better across the board or that 401(k)s are better across the board. In this article, I’m going to discuss the strengths and weaknesses of both to give you an idea of which path might be wisest for you. 

Is an IRA Right for You?  

IRAs are wonderful tools that allow our money to grow tax-deferred. In the case of traditional IRAs or contributory IRAs, we can put money in and deduct it from our income so that we don’t have to pay taxes that year on that income. However, suppose we choose that route with a traditional IRA. When it’s time for us to retire and start taking the money out to use it for our lifestyle, it’s taxable income used to count towards our provisional income. 

Our provisional income is what is used to determine how much of our social security will be taxed. As I am planning taxes for my clients and looking at withdrawals from a traditional IRA, it’s one of my least favorite places to have money come out of because it can occasionally bump my clients up into some of the higher brackets. It’s nice to have a balance of after-tax retirement accounts like Roths, before-tax retirement accounts like 401(k)s, all types of IRAs, and even have some cash or brokerage accounts (accounts that are taxed every year and have the potential to incur very low taxes based on the way you manage them). 

One of the greatest aspects of IRAs is that they can be self-directed. Now, this can mean many different things, but let’s discuss some of the basics. You can set up an IRA at a place like Charles Schwab, Fidelity, or even a bank, and you can buy any type of security that you want. What is security? Security is a stock, a bond, an ETF, or a mutual fund. You can put this in your account, and you can often have very low-cost options inside your IRA. 

So as we look at options for the IRAs, there’s a whole array. There are thousands of global options for bonds and stocks that you can choose from, and you’re able to guide those directions for your investments in any way you want. You don’t have to pick from a menu of limited investments like you would see in a 401(k) with your company. Another great benefit of a self-directed IRA is that it can be used to invest in alternative assets such as physical precious metals and put them into an IRA. 

There are some custodians (not Charles Schwab) like PENSCO, Millennium Trust, Equity Institutional, and many other self-directed IRA custodians that will allow you to put not only precious metals into your IRA but also real estate. So you can set up an LLC and use your IRA to buy shares into that LLC, give money to that LLC, and use it to buy real estate. In addition, you can put them in, deduct the money from your taxes, and have a tremendous amount of flexibility in how you can invest your money, particularly in the self-directed IRAs. 

Is a Roth Right for You? 

Roth IRAs have all the capabilities of the traditional IRAs, except when it comes to how they’re taxed. With a Roth IRA, you will have money that you put into the Roth after it’s already been taxed. However, it’s going to grow tax-deferred, and when it comes time for you to withdraw money from that IRA, it’s going to be withdrawn tax-free even if it has grown since you have put it in. So you put the money into a Roth IRA or contributed after-tax, and then you withdraw it tax-free, and it grows tax-deferred, tax-free, and at a loss. 

A Roth IRA is my favorite tool for my clients to have when they retire because I can pull the money out and use it to help keep my client’s provisional income low, sometimes enabling their Social Security to be taxed less or not at all. Aside from the Social Security taxation, I can also use Roth IRAs to prevent my clients from getting bumped into the next higher bracket. This is because the withdrawals and the distributions that come out of an IRA for someone who is retired or over the age of 59 and a half are not counted as income or any other type of taxable event. 

So you could potentially withdrawal $100,000 from a Roth IRA in one year, and your income would still only be whatever your other items were that weren’t the Roth. The Roth wouldn’t add to your income as a normal traditional IRA would. A Roth IRA has all the same flexibility of investments options as a traditional IRA, as I already stated. But when you’re retired, the more money you have in a Roth IRA, the happier you will be. 

Unfortunately, we don’t know what’s going to happen with taxes. We do know that the government debt is skyrocketing to levels that we can’t even understand. So it’s reasonable to believe that taxes will continue to go up for lower and lower-income amounts. In other words, they’ll continue to lower the brackets. One year, it might be for someone making $100,000 a year one year, their marginal rate or their highest rate is 22%. The next year, it might be 24% as they work their way down. But, of course, they’re going to hit the top brackets first. The people in the top 1% earners of the country will be hit the hardest, the fastest because they’re easy targets. But as they come down, they go to the top 1%, the top 2%, the top 3%, and eventually, it may impact you in retirement. So a Roth IRA is a good way to defend yourself against future tax increases by the government. 

Is a 401(k) Right for You?  

401(k)s are similar to traditional IRAs in that your money is put into them before it’s taxed. So, for example, in a given year, if you make $100,000, and you put $10,000 into a 401(k), you’re only going to be taxed on $90,000. Of course, with a 401(k), just like with an IRA, it’s going to grow tax-deferred. When you withdraw, it’s going to count as income. So when you withdraw money from that 401(k), again, it could bump you up into higher tax brackets. It could make it where a higher percentage of your Social Security is taxed, so just keep that in mind. You get to deduct it now, but you have to pay the piper later. 

However, a great benefit of the 401(k)s is that you can put much more money into them each year than with IRAs. That is an advantage of a 401(k) over an IRA. A disadvantage to 401(k)s compared to an IRA is that with 401(k)s, you typically will have limited investment choices from your company. You may only have fifteen to thirty choices to invest in unless your company has what’s called a self-directed option. More and more companies are allowing their clients to have self-directed 401(k)s to invest in thousands of securities. Again, securities are stocks, bonds, ETFs, and mutual funds. 

If you have a self-directed option for your 401(k), then they have almost no disadvantages compared to an IRA. Unless you want to invest in physical precious metals or real estate, the 401(k) will still be at a disadvantage to a self-directed IRA because inside of a 401(k), you cannot put precious metals or physical real estate. You can buy ETFs that invest in precious metals. Still, you cannot buy precious metals physically and store them inside of a 401(k) like you can with a self-directed IRA at certain custodians, as we discussed earlier in this article. 

401(k)s are great ways to defer large chunks of income compared to a traditional IRA. Even with the limited investment options, if your company has some options like U.S. stocks, foreign stocks, U.S. stocks, and foreign bonds that are low-cost, you can still put together a nice allocation inside a 401(k) if it’s low-cost. 

The Benefits of Investing in both a 401(k) and an IRA 

As you look at what you want to invest in between a 401(k) and an IRA, it’s important to think about how much you want to save, what your current investment options are if you decide to go inside of a 401(k), and then also, if you can balance it. Now, when I say “balance it,” I mean to balance your contributions. Can you put 50% into before-tax retirement plans like 401(k)s and traditional IRAs, and can you put 50% into, say, a Roth 401(k) or a Roth IRA? It’s nice to get a balance because we do not know the direction of taxes this country will take. In the future, are taxes going to be lower for your particular bracket or higher? Also, we have to ask ourselves, what is our bracket going to be in the future? Again, we don’t know the answer to that question. 

Balancing out your contributions, I think, is a wise way to mitigate tax risk. Rather than putting all of your eggs in the before-tax or all of your eggs in the after-tax bucket, I think it’s important to balance it out. And I will say that I’ve never had anyone that was retired that regretted the money they got in their Roth IRA once they were retired when they saw how we could use it to let them have a comfortable lifestyle and still keep them in a lower bracket than they would have been in had the withdrawals been coming from a traditional IRA. 


Also I encourage you to watch my free retirement video: https://go.thirdactretirement.com/strategy     

If you’re getting ready to decide on what type of IRA to start or a 401(k), you’re more than welcome to schedule a call with me at no cost and obligation, and I can go over with you what may be best for your situation. Just click on the button to schedule a 20-minute call, and it’ll be my pleasure to go over this with you. Click here and schedule it now: https://calendly.com/thomascloud/retirement-ready-success-call. Also, we will perform an audit on your portfolio (greater than $500,000) and review that with you as well at no cost or obligation what so ever.

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