Ep. 162 – 401k Versus IRA
Do you understand the difference and similarities between 401ks and IRAs? How can you make the two or one make sense for you as your retirement plan?
Both 401ks and IRAs are set up to encourage you to plan for your retirement, and you should have an analysis and a conversation on which one is good for you. But when you have the opportunity, moving from a 401k to an IRA gives you more flexibility and investment options.
In this episode of the Secure Your Retirement podcast, we talk about the differences and similarities between 401ks and IRAs. Listen in to learn how you can move your 401k funds into an IRA and its benefits.
In this episode, find out:
● A 401k is an employer-sponsored retirement plan, and an IRA is an individual retirement account.
● The pre-tax (traditional) 401k or IRA and the tax-free option (Roth).
● The difference between pre-tax and Roth 401ks/ IRAs and the tax benefits of each.
● The two major benefits of a 401k in terms of how it can be funded.
● In-service rollover – when you can move your 401k funds into an IRA and the benefits.
● A strategy on how we can access your 401k and make trades on your behalf.
● The simple process of doing an in-service rollover to move you from a 401k to an IRA.
● “On the funding side, 401ks typically are going to allow you to put in much more money than an IRA.” -Murs Tariq
● “In general, as long as you’re employed with the company, you cannot move from the 401k to an IRA.” – Radon Stancil
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Here’s the Full Transcript:
|Welcome everyone to the Secure Your Retirement Podcast. Radon Stancil here and Murs Tariq. We are certainly happy to be able to go through another topic to help you as you get close to and live throughout retirement. The topic today is 401Ks versus IRAs. What’s the difference? How do they work? And is there a reason that I should think about moving my 401k to an IRA? Why do I need to keep it in a 401k? What are my restrictions there? When am I able to move it? When is it even a possibility?
|So we’re going to kind of walk you through this world because a lot of times people wonder, Hey, I got a 401k, it’s through my company. Do I get a better deal with the company than if I moved it? And so we have questions around that and then the mechanics of how to be able to move the 401k to an IRA. So we hope this is helpful. We’ll walk you through what this looks like. So I think what we’ll do here first Murs if you could, could you just kind of help by explaining really what is a 401k and then what is an IRA?
|Yeah, the biggest difference between a 401k and an IRA, a 401k is what’s called an employer sponsored plan. So typically if you work for a company or even a small business, or even if you’re self-employed, it’s the company that is setting up this plan for you, that you can then contribute to. An IRA on the flip side is an individual retirement account. That means pretty much that almost anyone can open up one of these and manage it themselves. So that’s the two, that’s the really, the biggest difference as to the technicalities of it. One is a company sponsored plan. The other is an individual account that you could set up on your own. The idea behind both of these is that you’re setting these up for future use. You’re setting them up for retirement and it’s wise, the government wants you. They have put in specific tax benefits to using 401ks because they want to encourage you as well to start planning for your own retirement.
|Same with IRAs. There’s some, can be some tax benefits there. So getting into that. Now on 401ks and IRAs, typically there are two types. You’re going to have a pre-tax, which is called a traditional 401k or IRA. And then you’re going to have a tax free option typically, which is going to be a Roth 401k if your company has it, not all companies have that, but they are progressing towards that. So a Roth 401k option or a Roth IRA. The big difference between pre-tax and tax free in both cases is that you’re basically putting in dollars that you either have not paid tax on yet, which is going to be your traditional, your pre-tax. And then you get a tax benefit. So you don’t pay taxes on that, those dollars immediately, but it’s growing tax deferred now. And at some point, when you’re taking withdrawals in these traditional pre-tax assets in the future, you’re going to have to pay taxes on that money.
|Whereas the Roth options, both 401k and IRA, you pay the taxes on the money and then you put it into these accounts. And now the major benefit here, you’ve already paid the taxes on it and now they get to grow tax free. And the power here is that let’s say you start investing when you’re getting your first job in your early 20s and you’re doing tax free investments, they have a ton of time to grow tax free. And then those withdrawals are tax free, unlike in the pre-tax or the traditional scenario. So lots to think about when it comes to which one should I be using and which one is going to be the better scenario for me. We’re not really getting into all that today. It’s really, what’s the major difference. So those are the taxable differences, but ultimately these are vehicles that are designed to help you plan for retirement and to put money away.
|The other major difference is that on the funding side, 401ks typically are going to allow you to put in much more money to fund them a little bit heavier than a IRA. So right now, the IRA roughly, depending on your age, you can put in somewhere between six to $7,000 a year. On the 401k side, you can put up depending on your situation, there’s really two components to it. One is a salary deferral as an employee. So let’s say you work for a company and you want to say, max out your 401k contributions, you can put up, I believe the numbers right around 19,500 in a calendar year. Whereas the IRA is six or 7,000. So a huge benefit here where you can really maximize putting dollars into these retirement buckets. The other part of a 401k is that there could be an employer contribution.
|So employee is your salary deferral. That’s what you’re putting in. Then they’re on top of that could be an employer that’s also putting money in on your behalf. Some of you may think of this as an employer match that you get or an employer contribution. And so that number can take you up and it could be a possibility where when you take the employee and the employer put it together, you could have put in $50,000 or more into these accounts in a given year. So a lot of power in how a 401k can be funded. So I know I threw a lot out there, a couple different things, tax statuses, contributions, employer versus individual. So those are the main, big things. And I think another one is how you can now invest and grow the money. So you want to talk about that Radon?
|Yeah. And a little bit about the, I want to talk about the rules as well, as far as what are the guidelines? An IRA is an individual retirement arrangement, that the A is arrangement, not account.
|And so an individual retirement arrangement, which just means this is for you as an individual, you have all the controls. So you’re the one that are going to be able to go out. You can put it wherever you want to put it. You can pick Schwab, you can pick TD Ameritrade, you can pick Fidelity, you can pick wherever it goes. On the 401k, because Murs said it was an employer sponsored plan, they pick where it’s going to be. They pick what type of investments are going to be available in it. They make all of those arrangements.
|So on the 401k side, they make the rules. The company, the employer makes the rules. So what I’m going to talk to you about is in general, the rules, but you could have a company that has a couple different rules. So let’s just talk about in general. In general, as long as you are employed with the company, you do not have the ability to move money from the 401k to an IRA. That’s in general. There are some provisions in there for emergencies where you could get access to some money, but you can’t move the money out and say, shift it over into an IRA until a specific age. Most plans allow that at age 59 and a half, at 59 and a half, you can do what’s called an in-service rollover from that company plan, even if you’re still employed there. So why would you ever do that? Well, because if you go over to the individual retirement account, the IRA, if you go over there, you now have all the power. You’re able to go and have it invested in different investments.
|You’re able to have it moved and managed and help to have a financial advisor. So you get more options. Sometimes people think, well, yeah, but I work at a big company and they get us good rates. No, that is not the case. You’re in mutual funds over there and it’s the mutual funds that charge the fees. The company could have fees, or the administrator could have fees and the company may absorb all those fees and not pass those along to you. But the mutual funds do. When we go over to the IRA, we’re able to invest in individual stocks, we can invest in ETFs, exchange traded funds, and also the exact same mutual funds you would have in your 401k. So we don’t lose any benefit by going to the IRA. So many of our clients that are 59 and a half and older, if they want to work with an advisor like us and be able to have all the flexibility of the management, then they’ll move it over from the 401k to the IRA.
|So are there any taxes? Absolutely not because I’m doing an in-service rollover to another qualified plan. So I can move my 401k, whether it be traditional or Roth and move it over into a Roth or traditional IRA, then I have more flexibility. But what if I’m under 59 and a half and I’m employed with the same employer? I say it that way just for clarity. If I have a 401k at a previous employer, I do not have to wait to 59 and a half. I can move it. When I’m terminated from that employer, I can move it anytime I want to an IRA or to another employer plan.
|Now, what if though, I’m under 59 and a half and I’d like to have the assistance of a manager, I’d like to get help? Well, used to, we would pretty much tell folks we can give you some guidance. We can look at your funds and we can maybe give you some ideas, but really we can’t go in there because we don’t want to get your password and log in because there’s lots of regulations around that. But now we have a way that we can do it. So Murs, can you just walk us through what that looks like and how we can help somebody, even if you’re under 59 and a half with their management?
|Yeah. So, and this is a really cool concept. That is something that we’ve been using now and we like. It makes it very streamlined and simple for the client. It makes it a lot easier for us as well as the advisor as we try to manage these 401k buckets. And basically the way it works is we would set you up with a login and what you’re doing essentially is giving us access to your 401k for one reason and one reason only, and that is to monitor and make trade allocations if we need to. So say we want to move you from, go to a recent scenario of us taking our clients into cash because of market volatility. Say we wanted to do that in your 401k. We can click the buttons and do that.
|So essentially we have a login on one side, you have a login on the other, and then it creates this interface now that we can basically peek into your 401k, see what available options that you have because not all 401ks are created the same. It’s all about how the employer sets it up like Radon was saying. So we want to be able to see every single person’s individual options and then make decisions based off of that. So it’s basically an overlay of your 401k. We’re not going in. We’re not able to change anything as far as your contribution percentages, as far as your account addresses or anything like that. We don’t want to have that power, but we do want to have the power of us to actually make trades on your behalf.
|So it’s basically a simple little overlay with the power of some really cool technology that lets us look in, make trades. And then those trades get sent directly to your custodian like you would, if you were doing it yourself. So we have quite a few that are using it right now and the feedback is, is that it’s really smooth. And now the big thing is, is that they don’t have to manage it themselves. We can do that, just like we manage our client IRAs at our custodian. So it’s a pretty cool, neat process that if you’re interested in hearing about, we’re happy to talk to you more.
|I wanted to speak, I want to go back and just talk about the in-service part as well. One more little point on that. Sometimes people, they’re working at a company where they’re able to make those contributions. They want to make those contributions and they’re actually getting an employer match on top of that. I just wanted to be clear that if you do an in-service rollover, your 401k is still open. You still can contribute. You still get your match, nothing changes. But what a lot of our clients will do is they’ll roll over what they can roll over their balance in the account. And then each year after they get more funds in the account, they’ll roll that over each year. So I just wanted you to know that you still have your 401k, you still have your match. You still have everything there even if you do this thing called the in-service rollover.
|So we can wrap this up and say pretty much 401k versus IRA. IRA gives us a lot of flexibility. 401ks are good because we get bigger deferrals. So we’re not anti the 401k, but we’re just saying, when you have the opportunity, moving from a 401k to an IRA may make sense so that we have more flexibility. We have more options than we would in a 401k. So just what you want to do is you just want to do an analysis and have the conversation, which one would be better for me.
|Yeah. Also, on that point, I think it’s good to understand real quick, what the process is. Say you decide that you want to do a, what we’ve been saying, inservice rollover, the process is simple. So it’s not anything that requires a lot of time or a lot of research. Basically, you make the decision that, Hey, I want to have these funds. I want to manage them myself in my own IRA. Or I want to get help from an advisor. You make that decision. The process is basically we get on the phone with you. We call over to your 401k. So let’s say it’s Fidelity. We call over to the 401k. We speak to a representative and we say our client would like to do an in-service rollover of their available funds. And they walk us through a couple steps.
|Basically, we’re making sure that is a non-taxable event, which it almost always is. And then we are getting the funds sent. Basically it’s going to get sent directly to you. You’re going to get a check that says paid to the custodian for the benefit of your full name, which means that it is a non-taxable event. And then you get that check. You get it to us. We get it to your IRA where you directly deposit it to your IRA. From there now the accountant is able for you to buy whatever stocks you want to buy or let the advisor take over. So the process is really one simple phone call. Every now and then there’s a signature required. Again, it comes down to the employer, but I just wanted to give you an idea as to what that looks like.
|All right. Very good. Well, if you are listening to this, you’re on a walk, you’re on a drive, I want you to know that you can also go get it in written form. We have an article written on this topic with all the different little parts of what we just talked about. Go to our website, which is pomwealth.net. Go to the blog page. And there is where you’ll find the article on the 401k versus the IRA. We hope this has been helpful. If you have any questions, you like to hop on the phone with Murs or myself, go to the website again. Top right hand corner you’ll see a button that says complimentary phone conversation. Click on that. Our schedule comes right up. We are happy to hop on the phone and answer any questions around this topic. Maybe help you do an analysis to think it through. So please reach out to us if you have any questions. Thank you very much for listening. We again, we’ll talk to you next Monday.