401K? IRA? What Does It All Mean?

"Retirement is wonderful if you have two essentials: much to live on and much to live for."
- Unknown

At some point in your career (if it hasn't happened already), you'll be glad to hear that your company offers a 401k plan. Afterwards, you jump on that opportunity because you're supposed to have a 401k and because you're supposed to start putting money away for retirement. Then you hear things such as, "you have to start young so that you can retire with a lot of money." Yet, no one will tell you how much money you really need to retire or how it all works (Read How Much Money Do You Really Need to Retire?).

I sometimes feel as though the goal of an investment firm who is trying to have you sign up for their 401k plan is to try to confuse you even more. Think about it. If you're super confused about retirement and what it all means but you know that you 'need' a retirement plan, you'll most likely get frustrated and conclude that you don't want to deal with any of this and you just want someone to do this for you. So, you sign your life away because the sales person, or financial expert, told you that they'll take care of your retirement fund and that you need not to worry. Some of you might already have a retirement plan and some have not even thought about this yet. No matter where you are in your life, it's always good just to get a little bit more information. Therefore, today I wanted to explain very simply what the difference is between a 401k and an IRA.

Both a 401k and an IRA are intended to help you save money for retirement. Both a 401k and an IRA have legal terms, tax advantages (and some disadvantages) and a lot of jargon that confuses people. Other similarities include when you can take out funds and the availability of the funds for medical expenses, a first home purchase and education expenses. In other words, depending on your plan, you can use some of the funds in your account for certain expenses only. There are quite a few differences though:

• A 401k is typically set up by an employer (or a self-proprietor); an IRA is set up by an individual, not by the company
• In a 401k the employer typically sets the terms of the plan and can select to contribute to the employees plan; for an IRA there are no matching contributions available and the terms are selected by the individual
• A 401k plan allows you to take out loans from your account if needbe; an IRA doesn't have this feature
• A 401k makes it difficult to rollover the amount to another plan (which they might typically only allow you a rollover to another 401k plan); for an IRA, it's much easier to rollover the funds to a different account
• A 401k doesn't typically include beneficiaries; an IRA does allow beneficiaries to be included 

Tomorrow, I will go over the differences between the different types of 401ks and IRAs. The question most people ask me is: which one should I choose? My answer: keep doing research until you find the right plan. Some people are so selective when choosing a TV, a house or a car but when it comes to a retirement fund they're quick to sign a piece of paper without knowing what they're signing. Here are some resources to get you started:

IRA vs. 401k - Which Is Better For You? - an article from iravs401kcentral.com, a blog that strives to educate ordinary folks on retirement plans.

Retirement Basics: IRA or 401(k)? - a Q&A-style blog from U.S. News

Comparisons of 401(k) and IRA accounts - A wikipedia table that makes it easier to make a side-by-side comparison of the different types of plans

What are the differences between a 401(k) and an IRA? - an article from investopedia.com, a website for those interested in investing

Happy research!

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