Should you Invest in an Employer Plan or an IRA?

Most of us know that we should be saving and investing in the right places but it can be overwhelming and confusing to know exactly which is best and how to decide. This post will take a stab at some things to consider so you can determine whether you should put all your money in an employer plan (401k, 403b, etc.), in an IRA/Roth IRA, or in a little bit of both.

According to a report by Northwestern Mutual, about 1/3 of Americans have virtually nothing (less than $5,000) saved for retirement. https://news.northwesternmutual.com/2018-05-08-1-In-3-Americans-Have-Less-Than-5-000-In-Retirement-Savings There are varying reasons for this but as I alluded to above, it can be hard to decide to do it and then once it’s decided, we don’t know how!

You may hear that you should max out an employer plan (namely 401(k)) before contributing to an IRA. Some general benefits of an employer plan include: (1) if the plan offers Roth, you aren’t subject to phaseout rules based on your income and pre-tax contributions are always tax-deductible, (2) many employers will contribute or match some of your contributions giving you “free” money, (3) there are various auto features that help you save more without thinking, (4) many employers now include features such as loans to help for personal emergencies, and (5) you can contribute significantly higher amounts ($22,500 for a 401(k) in 2023 vs. $6,500 for an IRA in 2023 for example, without a catch up provision).

So why consider an IRA?

Obviously if your employer doesn’t offer a retirement plan as part of your benefits, an IRA/Roth IRA is the vehicle to consider for retirement savings. Other reasons to consider an IRA/Roth IRA include (1) greater flexibility with investment options since you aren’t subject to the investment options of the plan, (2) there are very few limitations on types of investments; for example real estate or commodities can be options, (3) if you have multiple previous employer plans, it can be a vehicle to roll all of those over and consolidate, although some employer plans offer that option as well (4) Roth IRAs offer the ability for penalty-free withdrawals for things like a first-time home purchase or higher education expenses that may not be available through an employer plan and (5) with the increase in ETFs and index funds available, sometimes you can find lower fees offered in IRAs and/or through robos than through a 401k.

Okay…so overall, what am I saying you should do? Well, as with everything in life…it depends.

Most would agree (including me) that if there is an opportunity to get matching contributions or any type of contribution from an employer, that you should at least start there and take advantage. After contributing enough to maximize the benefit from your employer, it may make sense to consider saving a little bit using an IRA or Roth IRA but this would be based on your situation and needs.

It’s always important to have a conversation with a financial professional to determine the best path for you but hopefully it gets a little easier to see some of the similarities and differences between an employer plan, like a 401k, and an IRA/Roth IRA.

***Keep in mind, the decision of pre-tax or roth for either vehicle isn't in scope for this post and you should consult a tax professional or financial planner.