Savings showdown: 401(k)s vs. IRAs

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Although anything from certificates of deposit to money market accounts to an envelope under the mattress can be used for retirement savings, 401(k)s and IRAs remain two of the most popular options. And with good reason. Both offer incentives that encourage workers to pad their retirement accounts while reducing their tax bill.

With both accounts offering similar benefits, you may be unsure which is best for your money. U.S. News spoke with three retirement savings experts to get their take on the pros and cons of 401(k)s and IRAs. Find out which account wins in a savings showdown.

401(k)s: "Free money" and legal protection in exchange for fewer options

In 2015, workers can deposit up to $18,000 tax-free into a 401(k) account. If you're age 50 or older you can add another $6,000 to that amount.

"The advantage of most plans is there is some type of matching contribution," says Michael Woomer, senior vice president of institutional and retirement plan services at Fort Pitt Capital Group in Pittsburgh.

A matching contribution is money deposited in a 401(k) account by an employer. Retirement experts call this match "free money" or a "guaranteed return" and say it's too good to pass up. It may be offered dollar-for-dollar or on a percentage basis, like 50 cents per dollar. In addition, matching contributions may be capped at a certain percentage of an employee's income. While the details may vary, all matching contributions are the same in that a worker needs to make his or her own deposits into the account to get the match.

The employer match is a main benefit of 401(k)s, but it's not the only reason to invest in these plans. Government regulations require employers to vet investment options and be transparent about fees. Therefore, "you'll most likely have professional oversight of the plan," says Chad Parks, CEO of Ubiquity Retirement + Savings, a company specializing in 401(k) plans and IRAs for individuals and small businesses.

In addition, the funds in a 401(k) are protected if you ever find yourself being sued or filing for bankruptcy. "Money in a 401(k) is off-limits to creditors," says Herb White, founder and president of Life Certain Wealth Strategies in Denver.

The main drawback of 401(k) plans is the lack of choices they offer. Since plans are controlled by your employer, you're limited to investing money in the funds your company chooses to offer.

IRAs: More choices but less protection and more contribution restrictions

IRAs, otherwise known as individual retirement accounts, also allow people to save money tax-free. However, these plans have a number of restrictions not found with 401(k) plans.

"With IRAs, there are income limits," Parks says. "If you make too much, you can't deduct [contributions]."

In 2015, your ability to deduct contributions to a traditional IRA begins to phase out if you earn more than $61,000 as a single tax filer or $98,000 if you're part of a married couple filing jointly. Roth IRAs – accounts that don't provide a tax deduction for deposits but allow you to withdraw money tax-free in retirement – have income eligibility limits starting at $116,000 for single taxpayers and $183,000 for married couples filing jointly.

Those with earnings less than the income limits are eligible to deposit up to $5,500 into an IRA in 2015. Those age 50 and older are able to deposit up to $6,500 in their account for the year.

One drawback of an IRA is that it doesn't offer the same level of creditor protection as a 401(k) plan. "Some states [protect] up to $2 million, but it doesn't rise to the level of what's offered to employer plans," White says. "Inherited IRAs are totally accessible to creditors."

Another downside of IRAs is that the onus is on you to vet investment options. "In an IRA marketplace, you might find they are selling you a [higher-priced] commissionable product," Parks says. "A drawback might be that you have a plan that's more expensive than it needs to be."

Despite that drawback, the wide open market – with no employer fund restrictions like with a 401(k) – is one of the biggest benefits of investing in an IRA. "You have more freedom where you want the money to go," Woomer says. "An IRA is also fairly portable. You can always move that money around." It's a relatively easy process to transfer money from one IRA to another at any time, whereas money in a 401(k) can't be rolled over to another plan unless a worker leaves his or her job.

And the winner is ...

All three finance experts tap the 401(k) as their first choice for retirement savings.

"The 401(k) clearly has more advantages than an IRA," Woomer says.

White recommends his clients invest in a 401(k) at least to the point of mixing out their employer's matching contribution. After that, he says it may make sense to open an IRA to diversify retirement investments.

As for those who are self-employed and don't have access to an employer-sponsored plan, Parks notes financial companies can set up 401(k) plans for those individuals. However, he says people shouldn't get too hung up on where to put their money. "Try not to let all the jargon and types of accounts get in the way of the act of savings," he says.

For those who want to have a comfortable cushion in retirement, the winning account may simply be the one that gets a deposit every month.

Copyright 2015 U.S. News & World Report

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