As a more general PSA: Even without matching, 401ks are still usually (but not always) superior to IRAs. The pros/cons work out differently by individual, so I’ll summarize the major differences (This comparison applies to “traditional”, non-ROTH accounts[1]):
401ks obviously require a job that offers them. Sometimes, IRAs are better by virtue of being the only option!
Only 401k savings are protected from creditors (i.e.: bankruptcy) under the ERISA act. That’s a big deal when making long-term financial plans!
IRAs have a substantially lower maximum annual limit for deductible contributions (For young unmarried individuals in 2023: $6,500 vs. $22,500). If you want to contribute more than $6,500 every year, you’re going to need a 401k.
The IRA deductible contribution limit is even lower if you’re earning >$73,000 in annual income. In fact, those earning >$83,000, can’t deduct any IRA contributions at all[2].
Only 401ks are paid before federal tax withholding. In other words; with an IRA, you’re paying the cost of letting the government borrow more of your income between annual tax returns relative to a 401k.
Under a 401k, your employer chooses the institution. This lack of choice generally translates into a worse investor experience (e.g.: higher fees, fewer options, worse support). IRAs are obviously superior in this regard![3]
You can combine a 401k and an IRA to bypass (Roth) contribution limits via the so-called “Mega-Backdoor Roth” (… you can’t make this shit up). This is great if you have so much income that you’ve already maxed out your main 401k’s contributions and still want to make even more (Roth-only) retirement contributions. If you’re already this rich, you should probably be learning about this from your accountant and not the internet…
tl;dr: If you make more than $70,000ish or just want to save really aggressively, 401ks are usually superior. IRAs are mostly useful if you don’t have the option of a 401k or prefer an IRA’s flexibility over a 401k’s higher contribution limit.
What’s a Roth retirement account? It’s a type of IRA/401k where contributions are not tax-deductible. Why would anyone want to give up those sweet tax deductions, though? Because in exchange your future retired self doesn’t have to deal with paying taxes when they take that money back out[4]. This is good for two groups of people: those with low taxable income (<$40,000) & those with excessively high spare income (see “Mega-Backdoor Roth” above). Another side-benefit is that you can withdraw your Roth contributions early with fewer penalties compared to a traditional retirement account (though I personally don’t think it’s a good idea to opt for a Roth for the “just in case” factor [5]) ↩︎
People who earn less than this can actually make deductible contributions to both an IRA and a 401k, but that’s only useful if you’re already hitting the $22,500 401k contribution limit… which is kind of hard to manage even near the upper cutoff of $83,000! ↩︎
It’s worth mentioning, however, that inactive 401ks (i.e.: 401ks from employers who no longer pay you) can also be freely transferred to any institution of your choosing via a “rollover” 401k account. ↩︎
FYI: with normal retirement accounts, they’re actually “tax deferred” rather than “tax free”. Basically, you still eventually get taxed when you take money out. Despite this, saving with a traditional retirement account is almost always worth it because putting in 20+% more money per dollar earned is a massive difference growth-wise. ↩︎
What’s my beef with using a Roth account as a hybrid retirement/rainy-day account? Well… it’s just not good enough at it to justify the opportunity cost of going Roth vs. Traditional. Keep in mind that usually only your original contributions can be taken out early – any growth is hands-off (before you retire) unless you pay a big penalty. At that point, it’s generally smarter to put your rainy-day savings into a high-interest savings account where you’ll have full liquidity and immediate access to the accumulated interest. If you’re really worried that you’ll need more money than that… consider that you could just declare bankruptcy if things go so hopelessly ass-up that digging out becomes impossible – your 401k is protected! ↩︎
I have heard that some people like to have part of their income in a ROTH account as a mega purchase account. The reasoning goes: if you are planning to make a very large one time withdrawal (for example, to make a down payment on a second home), taking that money out of a traditional 401k will be taxed as income and may put you in a high tax bracket, while if you are paying with ROTH money, you already paid taxes, at whatever your tax rate was while working.
That’s a very good point! Compared to using an investment account, using a Roth IRA to save for a down payment can potentially save you 15ish% in capital gains taxes. Much like the 401k vs. IRA distinction, however, there are tradeoffs:
Roth IRAs and traditional IRAs both share from the same $6,500 annual contribution limit “pool”. This effectively means that you’re sacrificing the opportunity to use a traditional IRA for retirement savings whilst using a Roth IRA to save for a down-payment. If you’re already saving under a 401k plan, this is basically a non-issue… but it’s actually a complete showstopper if an IRA is your only available retirement savings option. This bullet is not actually true, as pointed out elsewhere by @[email protected]. For clarity: contributions to a Roth IRA do not affect the limits associated with traditional IRAs and vice versa. You can contribute to a traditional IRA and that won’t limit your ability to use this strategy.
The main upside of using a Roth IRA to save for a down-payment is that you get to avoid paying capital gains taxes on profits generated by the IRA. This is because, unlike investment accounts, any gains produced from Roth retirement accounts are tax-exempt. It’s effectively a ~15% discount on your payment![1]
The catch is that Roth IRAs are retirement accounts. You’re not normally allowed to take the gains out early like this. The only reason the strategy works at all is because there’s a special exception for this. In order to qualify, you must be a first-time home buyer and you must have had the Roth IRA account open for at minimum 5 years. You only get one chance to do this and you need to start laying the groundwork at least 5 years in advance!
Another catch is that – if you get cold feet about buying a home – you basically lock yourself out of using that Roth growth money until you retire (unless you pay a hefty fee).[2]
tl;dr: If you’re a first-time home buyer and you have spare IRA headroom that you weren’t otherwise planning on usingand you have a healthy enough emergency fund that you can handle the risk(?) of accidentally saving more than intended for retirement, then there’s a Roth IRA out there waiting with your name on it.
This assumes that your gross yearly income is already > $40,000. If for whatever reason the sum total of your income is less than $40,000 during the year that you plan to buy your home (including the gains from the fund that you’re about to cash in!), then you’ll actually already be exempt from paying any capital gains tax. For non-retirees this is a pretty rare situation (unless you’ve been hiding something from the IRS…), but it prooobably happens? If this situation applies to you (and you don’t mind getting audited), then you’re basically free and clear to load up an investment account with as much money as you please and still reap those tax-free returns when the time comes – no IRA shenanigans necessary. ↩︎
This is actually a pretty interesting tradeoff, because it’s an upside for some and a downside for others. Take a hypothetical person with a $5,000 budget to split between retirement and saving for a down payment, for example: If they need to back out of buying a home, it’s actually perfect that their down payment savings are locked into their IRA – they were already planning on locking that money in and they still get to reap nice tax benefits in retirement. On the other hand, if that same person was financially counting on escaping from a bad rent situation… now they’re going to come up short of where they had previously expected to be in terms of cash-on-hand. ↩︎
Actually, there’s a carveout for first-time homebuyers that applies to Roth IRA distributions, assuming the account is more than 5 years old. Their example actually holds true even if the applicability of the strategy is a lot more narrow than the commentor first expressed.
One of the (exceedingly few!) nice things about personal finance is that the less money you have, the less complicated the advice gets. If all you’ve got is enough to get by, all you really need to know is this:
Keep the checking account in the black
Whenever possible, completely pay down credit cards
Satisfy minimum payment requirements on other loans
Bills
With a little luck, you can actually manage a surprising range of financial gymnastics using nothing more than credit cards. Credit cards enable you to avoid payday loans, enable you to weather short-term hardships, (potentially) help you access more affordable home/auto loans, and even (potentially) pay you in the form of cashback rewards/promos in exchange for nothing more than occasionally putting up a non-revolving balance. Don’t get me wrong – credit cards are dangerous… but so is fire. Don’t play with fire, but don’t fear it either. Knowledge is power here.
Beyond that… good luck and godspeed on your life financial journey. If you ever need further guidance, I advise exploring this Bogleheads article. Of course, you can also feel free to PM me anytime if you have questions… though, full disclosure: I’m just a confident nerd on the internet with literally no credentials whatsoever – let alone finance credentials!
401ks are still usually (but not always) superior to IRAs.
Not usually, just very rarely.
Unless you declare bankruptcy or have high income, your first step is to fund your match but then max out HSA and IRA first. Once those are hit, then you should fund your 401(k).
401(k)s have fewer choices and come with fees. Pretty much all IRA accounts will allow you to choose any investment and have no fees.
The IRA deductible contribution limit is even lower if you’re earning >$73,000 in annual income. In fact, those earning >$83,000, can’t deduct any IRA contributions at all
Roth IRAs have a soft cap at $129K/$204K with the hard cap at $144K/$214K. This is also your MAGI, not your salary. Only Traditional has that lower limit. You can also use the non-deductible Traditional IRA for a backdoor Roth if you’re over the limit.
Not usually, just very rarely. […] 401(k)s have fewer choices and come with fees. Pretty much all IRA accounts will allow you to choose any investment and have no fees.
FWIW, I do bring this up in my main post – it’s just that I’m drawing on my own personal experiences and… in my experience I’ve always been able to get the options I want without extra fees. In retrospect, that’s probably just because of two things:
I’m not a particularly choosy investor so the relative lack of salience gives me a blindspot when considering the investor experience.
I no longer qualify for deductible IRA contributions so I naturally think about them less than I probably should when giving advice to other people.
In any case, I accept your argument and apologize for the oversight.
Roth IRAs have a soft cap at $129K/$204K with the hard cap at $144K/$214K. This is also your MAGI, not your salary. Only Traditional has that lower limit. You can also use the non-deductible Traditional IRA for a backdoor Roth if you’re over the limit.
Err… you can’t deduct contributions to Roth IRAs, period. Moreover, I specifically say beforehand that I’m not talking about Roth accounts in the main bullet points: “This comparison applies to “traditional”, non-ROTH accounts”. Forgive me for saying so, but I also felt no need at the time to explain MAGI for the purposes of this comparison – that’s probably on me as a careless layman, so thanks for putting that out there.
EDIT: Credit where it’s due, I did mess up talking about the Roth IRA limit in a different part of the thread (here). The error is now corrected and the person responsible has been sacked.
One potential advantage to IRAs is that you have a much broader choice of investments. To be fair though, the investment choices have been decent in the 401ks I’ve had.
As a more general PSA: Even without matching, 401ks are still usually (but not always) superior to IRAs. The pros/cons work out differently by individual, so I’ll summarize the major differences (This comparison applies to “traditional”, non-ROTH accounts[1]):
tl;dr: If you make more than $70,000ish or just want to save really aggressively, 401ks are usually superior. IRAs are mostly useful if you don’t have the option of a 401k or prefer an IRA’s flexibility over a 401k’s higher contribution limit.
What’s a Roth retirement account? It’s a type of IRA/401k where contributions are not tax-deductible. Why would anyone want to give up those sweet tax deductions, though? Because in exchange your future retired self doesn’t have to deal with paying taxes when they take that money back out[4]. This is good for two groups of people: those with low taxable income (<$40,000) & those with excessively high spare income (see “Mega-Backdoor Roth” above). Another side-benefit is that you can withdraw your Roth contributions early with fewer penalties compared to a traditional retirement account (though I personally don’t think it’s a good idea to opt for a Roth for the “just in case” factor [5]) ↩︎
People who earn less than this can actually make deductible contributions to both an IRA and a 401k, but that’s only useful if you’re already hitting the $22,500 401k contribution limit… which is kind of hard to manage even near the upper cutoff of $83,000! ↩︎
It’s worth mentioning, however, that inactive 401ks (i.e.: 401ks from employers who no longer pay you) can also be freely transferred to any institution of your choosing via a “rollover” 401k account. ↩︎
FYI: with normal retirement accounts, they’re actually “tax deferred” rather than “tax free”. Basically, you still eventually get taxed when you take money out. Despite this, saving with a traditional retirement account is almost always worth it because putting in 20+% more money per dollar earned is a massive difference growth-wise. ↩︎
What’s my beef with using a Roth account as a hybrid retirement/rainy-day account? Well… it’s just not good enough at it to justify the opportunity cost of going Roth vs. Traditional. Keep in mind that usually only your original contributions can be taken out early – any growth is hands-off (before you retire) unless you pay a big penalty. At that point, it’s generally smarter to put your rainy-day savings into a high-interest savings account where you’ll have full liquidity and immediate access to the accumulated interest. If you’re really worried that you’ll need more money than that… consider that you could just declare bankruptcy if things go so hopelessly ass-up that digging out becomes impossible – your 401k is protected! ↩︎
I have heard that some people like to have part of their income in a ROTH account as a mega purchase account. The reasoning goes: if you are planning to make a very large one time withdrawal (for example, to make a down payment on a second home), taking that money out of a traditional 401k will be taxed as income and may put you in a high tax bracket, while if you are paying with ROTH money, you already paid taxes, at whatever your tax rate was while working.
That’s a very good point! Compared to using an investment account, using a Roth IRA to save for a down payment can potentially save you 15ish% in capital gains taxes. Much like the 401k vs. IRA distinction, however, there are tradeoffs:
Roth IRAs and traditional IRAs both share from the same $6,500 annual contribution limit “pool”. This effectively means that you’re sacrificing the opportunity to use a traditional IRA for retirement savings whilst using a Roth IRA to save for a down-payment. If you’re already saving under a 401k plan, this is basically a non-issue… but it’s actually a complete showstopper if an IRA is your only available retirement savings option.This bullet is not actually true, as pointed out elsewhere by @[email protected]. For clarity: contributions to a Roth IRA do not affect the limits associated with traditional IRAs and vice versa. You can contribute to a traditional IRA and that won’t limit your ability to use this strategy.tl;dr: If you’re a first-time home buyer
and you have spare IRA headroom that you weren’t otherwise planning on usingand you have a healthy enough emergency fund that you can handle the risk(?) of accidentally saving more than intended for retirement, then there’s a Roth IRA out there waiting with your name on it.This assumes that your gross yearly income is already > $40,000. If for whatever reason the sum total of your income is less than $40,000 during the year that you plan to buy your home (including the gains from the fund that you’re about to cash in!), then you’ll actually already be exempt from paying any capital gains tax. For non-retirees this is a pretty rare situation (unless you’ve been hiding something from the IRS…), but it prooobably happens? If this situation applies to you (and you don’t mind getting audited), then you’re basically free and clear to load up an investment account with as much money as you please and still reap those tax-free returns when the time comes – no IRA shenanigans necessary. ↩︎
This is actually a pretty interesting tradeoff, because it’s an upside for some and a downside for others. Take a hypothetical person with a $5,000 budget to split between retirement and saving for a down payment, for example: If they need to back out of buying a home, it’s actually perfect that their down payment savings are locked into their IRA – they were already planning on locking that money in and they still get to reap nice tax benefits in retirement. On the other hand, if that same person was financially counting on escaping from a bad rent situation… now they’re going to come up short of where they had previously expected to be in terms of cash-on-hand. ↩︎
You will pay tax on the growth, but not on the initial deposit. But that’s just because you would be taxed twice.
Actually, there’s a carveout for first-time homebuyers that applies to Roth IRA distributions, assuming the account is more than 5 years old. Their example actually holds true even if the applicability of the strategy is a lot more narrow than the commentor first expressed.
Damn… well that’s getting saved for if I ever have spare money again
One of the (exceedingly few!) nice things about personal finance is that the less money you have, the less complicated the advice gets. If all you’ve got is enough to get by, all you really need to know is this:
With a little luck, you can actually manage a surprising range of financial gymnastics using nothing more than credit cards. Credit cards enable you to avoid payday loans, enable you to weather short-term hardships, (potentially) help you access more affordable home/auto loans, and even (potentially) pay you in the form of cashback rewards/promos in exchange for nothing more than occasionally putting up a non-revolving balance. Don’t get me wrong – credit cards are dangerous… but so is fire. Don’t play with fire, but don’t fear it either. Knowledge is power here.
Beyond that… good luck and godspeed on your life financial journey. If you ever need further guidance, I advise exploring this Bogleheads article. Of course, you can also feel free to PM me anytime if you have questions… though, full disclosure: I’m just a confident nerd on the internet with literally no credentials whatsoever – let alone finance credentials!
Not usually, just very rarely.
Unless you declare bankruptcy or have high income, your first step is to fund your match but then max out HSA and IRA first. Once those are hit, then you should fund your 401(k).
401(k)s have fewer choices and come with fees. Pretty much all IRA accounts will allow you to choose any investment and have no fees.
Roth IRAs have a soft cap at $129K/$204K with the hard cap at $144K/$214K. This is also your MAGI, not your salary. Only Traditional has that lower limit. You can also use the non-deductible Traditional IRA for a backdoor Roth if you’re over the limit.
FWIW, I do bring this up in my main post – it’s just that I’m drawing on my own personal experiences and… in my experience I’ve always been able to get the options I want without extra fees. In retrospect, that’s probably just because of two things:
In any case, I accept your argument and apologize for the oversight.
Err… you can’t deduct contributions to Roth IRAs, period. Moreover, I specifically say beforehand that I’m not talking about Roth accounts in the main bullet points: “This comparison applies to “traditional”, non-ROTH accounts”. Forgive me for saying so, but I also felt no need at the time to explain MAGI for the purposes of this comparison – that’s probably on me as a careless layman, so thanks for putting that out there.
EDIT: Credit where it’s due, I did mess up talking about the Roth IRA limit in a different part of the thread (here). The error is now corrected and the person responsible has been sacked.
Haha nice post i agree 100% just sharing that those without employment can still save to retire.
I’ve never had someone “Haha” in response to a tax code explainer before… but I’ll take it
One potential advantage to IRAs is that you have a much broader choice of investments. To be fair though, the investment choices have been decent in the 401ks I’ve had.