401(k) or IRA: Which Retirement Saving Choice Is Right for You?

November 09, 2010

As you open your most recent 401k statement, take a few minutes to check out a few important features of your retirement plan.  What is the employer match, if any?  Many companies have either reduced or eliminated the match over the past few years.  At the very least, you should be contributing up to the amount your company is willing to match.  But, what if you don’t have a match at all?  Should you contribute to an IRA instead?

Here are some points to consider in favor of re-directing your dollars towards an IRA:

  • Tax-free growth – if you have many years before retirement, or are in a low tax bracket, contributing to a Roth IRA may provide a better tax advantage than your pre-tax 401k.  Less than 40% of employers have made the Roth 401k option available.
  • Lower fees and expenses – many small employers have high fees and expenses associated with managing the funds in their 401k (I’ve seen them as high as 2%!) and some 401k plans hit their participants with a quarterly or annual maintenance fee (typically $10 per employee).  An IRA invested in a good no-load mutual fund will usually have lower management expenses and many will waive the annual account fee if you keep a minimum balance.
  • Investment options – if your 401k has poor performing funds, or a minimal list to choose from, investing in an IRA opens up almost an unlimited variety of investment options.

Here are some points to consider in favor of still contributing to your 401k:

  • Payroll deduction – even without a match, the automated savings from payroll deduction can be the easiest way to build your retirement nest egg.  What you don’t see in your net pay, you are not tempted to spend.  When funding an IRA, many investors put it off and then struggle to write the check on April 15th to make their annual contribution.
  • Institutional pricing – many large employers with sizeable assets in their retirement plan use institutional funds which are typically less expensive than their retail equivalents.  According to the Investment Company Institute, the median expense ratio for a 401k is 0.72%, compared to a retail mutual fund that you might invest an IRA in that has an average expense ratio of over 1%.
  • Stable Value Fund Option – you may have a Stable Value or Guaranteed Income Contract as a conservative investment option that yields a higher rate of return than you could find with an IRA CD.  Current rates for the average Stable Value Fund are hovering around 3%.
  • High contribution limits – in 2010, you can contribute as much as $16,500 ($22,000 if you are age 50 or older) to your 401k, but the limit is a much lower $5,000 ($6,000 if you are age 50 or older) for an IRA.

Either way, the most important factor to having a retirement nest egg is to save throughout your career, and to pay attention to all the options you have available.