401(k) plans and IRAs are two of the most popular ways of building a retirement fund. Here is a brief overview of these two options:
401(k) plans are primarily employer-sponsored retirement plans for employees. Under these, the company can offer you some investment options to choose from. The 401(k) account is managed by the employer, where they deposit a part of your wage along with a matching contribution from the company. These funds are invested by investment experts, depending on your plan options, into various instruments.
A 401(k) account will continue until you reach 59 ½ years of age. You can then make withdrawals without attracting a penalty. The funds in your 401(k) plan would have multiplied by that time as a result of accrued dividends, compound interest and capital growth. The 401(k) plan funds in your account are yours and do not depend on your employment status. If you get laid off or quit work, the funds remain where they are.
There are, however, restrictions to the sum you can deposit into your 401(k) account every year. These are set by the IRS, employer plan rules and regulations as well as government laws. Refer to the latest IRS publications for all the information you need on 401(k)s.
IRA (Individual Retirement Accounts)
An IRA is a retirement account where you can pick the investments on your own in accordance with your personal preferences. Only income earned as wages, bonuses and commissions can be contributed to an IRA, with investment income being disallowed. For 2010, those under 50 years of age can contribute up to $5,000 to their IRA.
You can opt for a traditional IRA or a Roth IRA. In a traditional individual retirement account, the contributions are tax deductible while those in a Roth IRA are not tax deductible.
The main difference between a 401(k) and an IRA is that with the 401(k), you can deposit money even after you turn 70 ½ years of age whereas contributions have to stop just before that age in an IRA. When you reach 70 ½ years of age, you will have to start taking distributions from your individual retirement account. If you plan to work past that age, the 401(k) should be your plan of preference. In both these plans, you can nominate beneficiaries to inherit the funds upon your death.