Sometimes 401(k)s are Better than IRAs

Sometimes 401(k)s are Better than IRAs

I get really annoyed when people quote any talking heads without taking into account one’s personal situation.  I am not sure why, but I can’t stand blind faith in anyone except maybe your version of a Creator.

A LOT of personal finance bloggers, Talk Show Hosts, and house wives all over the country take the words coming out of Suze Orman’s mouth as gold which can’t possibly be wrong.  But everyone’s situation is different – which is why not every sound bite can possibly apply to everyone.

While I generally believe that one should only put into a 401(k) up to the extent that your company matches and then into your IRA/Roth IRA.  The reasons are one that are often cited lower fees (usually) & more investment options.

But are there any positives where you should ignore these golden words of wisdom?  Absolutely, and I’d love to share a few with you.

What makes 401(k)s better than IRAs?

1) You can take Loans out of a 401(k)

The IRS makes it unequivocally clear that,

Loans are not permitted from IRAs or from IRA-based plans such as SEPs, SARSEPs and SIMPLE IRA plans. Loans are only possible from qualified plans that satisfy the requirements of §401(a), from annuity plans that satisfy the requirements of §403(a) or 403(b), and from governmental plans. (Code §72(p)(4); Reg. § 1.72(p)-1, Q&A-2)

I’d love to know how many people didn’t know the quoted gem?

2)  401(k) Often Offer “Free Money”

Not going to spend time on this one, but this is the magical match that people always talk about.  While it is declining in popularity, many companies still offer it.

3)  401(k) Contributions are “More Automatic”

Most people would agree, that Personal Finance is mental.  Well, you tell me what is easier

  • Me – Getting my paycheck NET and my retirement account being funded no thought necessary OR…
  • Me – getting my paycheck it going into my checking account and then getting the money being pulled out later on?

Similarly, how much easier is it to sign on to vanguard or fidelity to stop that withdrawal vs. having to talk to someone in HR and admitting aloud that I don’t want to contribute to retirement?

4)  Hardship Withdrawals

Most people don’t even know how important those 2 words really are!  What is a Hardship Withdrawal? A Hardship Withdrawal are those withdrawals that are not subject to the 10% penalty if you under 59 1/2.  Want more specifics? As always, I go to the source the IRS:

For a distribution from a 401(k) plan to be on account of hardship, it must be made on account of an immediate and heavy financial need of the employee and the amount must be necessary to satisfy the financial need. The need of the employee includes the need of the employee’s spouse or dependent. (Reg. §1.401(k)-1(d)(3)(i))

Under the provisions of the Pension Protection Act of 2006, the need of the employee also may include the need of the employee’s non-spouse, non-dependent beneficiary.

Whether a need is immediate and heavy depends on the facts and circumstances. Certain expenses are deemed to be immediate and heavy, including: (1) certain medical expenses; (2) costs relating to the purchase of a principal residence; (3) tuition and related educational fees and expenses; (4) payments necessary to prevent eviction from, or foreclosure on, a principal residence; (5) burial or funeral expenses; and (6) certain expenses for the repair of damage to the employee’s principal residence. Expenses for the purchase of a boat or television would generally not qualify for a hardship distribution. A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred by the employee.
(Reg. §1.401(k)-1(d)(3)(iii))

Within this same article the question is asked: “Are hardship distributions allowed from an IRA?”

Not exactly. There is generally no limit on when an IRA owner may take a distribution from his or her IRA, although there may be unfavorable tax consequences, such as an additional tax on early distributions. However, certain distributions from an IRA that are used for expenses similar to those that may be eligible for hardship distributions from a retirement plan are exempt from the additional tax on early distributions. Specifically, a distribution from an IRA for higher education expenses or to finance a first-time home purchase is exempt from the early distribution tax.
(Code § 72(t)(2)(E),(F))

Am I missing any other advantages?

Final Thoughts on What is Better a 401(k) or an IRA

They are different animals used to accomplish the same goal (i.e. save for retirement).  That being said, there are no rules saying you can’t have both (although there are plenty of rules of how much you can contribute if you have both – so check with your financial professional).

I think I made it clear before, I think IRAs are probably a great bet for most, my main point is that you can’t always believe what you hear on CNBC, Oprah, or on a Personal Finance blog – even this one!

9 Responses to Sometimes 401(k)s are Better than IRAs

  1. Ok, I'll give you another reason to replace dropped one:
    Say you are above the phaseout range for being able to deduct an IRA contribution, and you've make post-tax deposits over the years. Starting in 2010, you can convert that money to a Roth with tax due only on the growth, not the money you deposited post tax. If you roll the 401(k) money to an IRA, it gets counted in the mix and tax must be paid in proportion to the pretax money you have. The IRA from the 401(k) transfer and the existing IRA must be treated as “one IRA” with pre and post tax component. Keeping the the 401(k) avoids this.

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