The best time to begin investing in a 401(k) or IRA is now. The cumulative years of compound interest and tax advantages can add up to hundreds or even thousands of dollars over time. You don’t want to miss out adding to your nest egg as this could determine how soon you are able to retire.
Even if you don’t have access to a 401(k) plan at work, anyone with earned income from a job can open an IRA.
However, there are rule changes that affect 401(k) plan accounts and IRAs that you should watch out for. Many of these changes are relatively minor but some can have a substantial impact on the way you use your retirement accounts.
The changes to 401(k)s and IRAs in 2019 will be discussed later, but first a little background on each.
What is a 401(k)?
A 401(k) is an employer-offered retirement plan that can offer you a substantial tax break on money you save for retirement.
The best thing about investing in a 401(k) plan is that it is automatic, consistent, and the money is not easy to access. The money comes out of your pay automatically and does not get deposited into your checking or savings account where the funds can be withdrawn easily and used for frivolous purchases. Investing in a 401(k) is consistent because investing occurs each time you are paid your salary. This, in turn, makes it easier to save money each month.
The biggest benefit of 401(k) plans is that you’re allowed to avoid paying immediate income tax on the money you contribute toward your retirement. Instead, the pre-tax money is invested on a tax-deferred basis, with no tax consequences for any income or gains generated within your 401(k) account. Only when you withdraw money from your 401(k) will you pay tax on it at your income tax rate, which is often lower in retirement than in your working years.
Some employers choose to make additional contributions toward their employees’ 401(k) plan accounts. These extra contributions usually take the form of either employer matches, where the employer’s contribution amount depends on how much each employee contributes.
You can find out who invented the 401(k) and what year it began.
What is an IRA?
An Individual Retirement Account (IRA) is a form of “individual retirement plan” provided by financial institutions that provide tax advantages for retirement savings. One key benefit of IRAs is that you’re offered a wider range of investments in your retirement account than those offered in most 401(k) plans.
With an IRA, you can invest not only in the mutual funds and ETFs that 401(k) plans prefer but also in individual stocks, bonds and bank certificates of deposit. Some IRA providers even let you invest in more exotic assets like precious metals or real estate.
An IRA, just like with a 401(k), allows income from interest, dividends, and capital gains to compound each year without taxes eating away it.
Nonetheless, the benefits of an IRA account are not as robust as the 401(k) plan.
The biggest disadvantage is that there is no employer match. Also, the government limits the amount of money you can put into an IRA each year. Most people under 50 can contribute no more than $5,500 a year; a limit that rises if you are older.
There are two types of IRAs: Traditional IRA and a Roth IRA.
I discussed the difference between a Traditional IRA and a Roth IRA and which is better for you in a previous post.
An Individual Retirement Account (IRA) is a form of “individual retirement plan” provided by financial institutions that provide tax advantages for retirement savings. One key benefit of IRAs is that you’re offered a wider range of investments in your retirement account than those offered in most 401(k) plans.
With an IRA, you can invest not only in the mutual funds and ETFs that 401(k) plans prefer but also in individual stocks, bonds and bank certificates of deposit. Some IRA providers even let you invest in more exotic assets like precious metals or real estate.
An IRA, just like with a 401(k), allows income from interest, dividends, and capital gains to compound each year without taxes eating away it.
Nonetheless, the benefits of an IRA account are not as robust as the 401(k) plan.
The biggest disadvantage is that there is no employer match. Also, the government limits the amount of money you can put into an IRA each year. Most people under 50 can contribute no more than $5,500 a year; a limit that rises if you are older.
There are two types of IRAs: Traditional IRA and a Roth IRA.
I discussed the difference between a Traditional IRA and a Roth IRA and which is better for you in a previous post.
Changes to 401(k)s and IRAs in 2019
Here’s a brief summary of the changes that took effect in 2019 for 401(k) accounts and IRAs.
- Employee contribution limits to 401(k)s for those younger than age 50 rose $500, to $19,000.
- Employee 401(k) contribution limits for those 50 or older rose $500, to $25,000.
- Total combined employee and employer 401(k) contribution limits rose $1,000, to $56,000 for those under 50 and to $62,000 for those 50 or older.
- The compensation used in the definition of a highly compensated employee rose by $5,000, to $125,000.
- Contribution limits on IRAs for those younger than age 50 rose $500, to $6,000.
- Contribution limits on IRAs for those 50 or older rose $500, to $7,000.
- The income limits for deductibility of traditional IRA contributions rose slightly, with the exact amount of the increase varying by filing status and whether you or your spouse are eligible for a workplace retirement savings plan.
- The income limits for contributing to a Roth IRA rose slightly, as well.
- Contribution limits on SIMPLE 401(k) and SIMPLE IRA plans rose $500, to $13,000 for those under 50 or $16,000 for those 50 or older.
Make the most of your retirement savings
As I stated at the beginning of this post, it’s important to set money aside for retirement using your 401(k) account, an IRA, or both as soon as possible. The start date can make a big difference in how much you accumulate and when you will be able to retire.
Over time, what started off as a relatively small amount grows larger and larger as the power of time and compound interest work together to build your retirement account.
By understanding the yearly changes with these retirement-savings vehicles, you’ll be better able to take boost your overall savings and ensure your financial security in retirement.