Does the thought of living your golden years scare the daylight out of you? Unless you’re already independently wealthy, you should no doubt be concerned with the financing of your future retirement years. I doubt how many these days are independently wealthy, have recently won millions in the lottery or have inherited lifetime millions from a close relative. Thus, looking ahead and planning for 20, 30 or 40 years from now will definitely spell a big difference when you finally retire. When planning for retirement, many people wonder “what is the different between IRA and 401k accounts?” Both the IRA (Individual Retirement Account) and the 401k are ways to save money for retirement, or occasionally for major purchases such as the college education of a child or a purchase on a house. The principle difference between the two is that Individual retirement accounts, also called “IRAs” are offered through financial institutions, while 401k plans are typically provided through employers. Each plan has unique benefits to consider. There are more differences between the IRA and the 401k.

Some people have both because of one of the major differences between the plans. A 401k may have a maximum savings amount or a maximum percentage of your pay that you can place in an account. You might be limited to a 10% contribution of your salary, and as of 2008, the maximum tax-free amount you can place in a 401k is $16,000. This will adjust each year if inflation occurs. For 2006 and 2007, IRA contribution limits are $4,000; it jumps to $5,000 for 2008.

Many employers make matching contributions to their employee’s 401k accounts, typically as much as 50 cents on the dollar for up to 6 percent of the employee’s salary. Some are even more generous. That amounts to free money being deposited and compounding in your retirement fund. If your 401k offers a matching contribution, that’s usually the best place to start. For example, let’s say you make $50,000. Your employer matches your 401k contributions dollar-for-dollar up to 6% of your salary, which for you amounts to $3,000. In this case, the first $3,000 of savings should go into your 401(k) plan. Why give up free money? Another advantage is that you can generally borrow money from your 401k without penalty (as long as you pay it back, of course). You can’t borrow from an IRA.

However, traditional IRAs have many advantages, as well. Currently, you probably have a far wider variety of investment choices with IRAs than with a 401k. Many 401k plans allow for very limited choices. Generally, you are free to invest the money in your IRA however you chose. Some common Roth IRA investment options are bonds, common stocks,index funds, certificates of deposit (CDs) and real estate investments trusts. The flexibility that comes with being able to invest your Roth IRA as you choose, as well as being able to withdraw funds early or leave them long after your 71st birthday, make the Roth IRA immensely popular. Another benefit of contributing to a Roth IRA is that there’s no mandatory withdrawal date. This is very important when looking at investment options for yourself. Most retirement investment programs require you to begin making withdrawals on your investment when you reach 70 ½ years of age. The Roth IRA has no such requirement. In fact, you can contribute to your Roth IRA with no intention of ever making withdrawals, and your beneficiaries can inherit the account with no penalties attached. Just imagine how much the 25-year-old’s initial $5,000 Roth IRA investment would have grown after 60 years of earning potential.

Qualifications for 401k and Roth IRA

As Roth IRA was developed specifically with middle-class Americans in mind, there are obviously income restrictions and contribution limitations that comes with it. Unfortunately, if you’re single and have an adjusted gross income (AGI) of $110,000 or more, or if you’re married and filing your taxes jointly and have an AGI of $160,000 or higher, you’re not eligible to contribute to a Roth IRA. Think about investing those six-figure salaries into other high-return retirement options. Another income rule with Roth IRAs is that you must earn a minimum annual income equal to what you contribute to your Roth IRA. If you earn only $3,000 a year, you can contribute no more than $3,000 annually to your Roth IRA. Everyone else can contribute a set amount, determined by age, annually.

The basic criteria for becoming eligible for a 401k Retirement Fund are simple. First, you must be employed by a business or company that currently offers the 401k Retirement Plan. Another requirement is that you cannot simply begin activity in the 401k program as soon as you join a company. Even if you are able to afford contributions and desire to invest in your retirement, you must be working for a business in the 401k program or you cannot invest in it. There will be a time limit imposed during which you are not eligible. Depending upon your company, the time period will be different, but it is never longer than a year. Finally, you must be over the age of 21, even if you are employed full time and receive other benefits.

If you haven’t begun to save for retirement, what are you waiting for? The sooner, the better rule always works best. Learn more of 401k and IRA to know which retirement accounts make the most sense and to which you are most qualified, then start filling them up! Til my next posts in Save.net!