This post originally appeared on www.michaelmorrow.org.
Qualified plans are any kind of employer-sponsored retirement plan or individual retirement plan. The most common employer-sponsored retirement plan is a 401(k). Both 401(k)s and IRAs are wrappers for different kinds of assets. Mutual funds tend to be the most common asset held in qualified plans. This post looks at five elements of qualified plans: liquidity, safety, expenses, rate of return, and tax efficiency.
As long as you remain with your employer, 401(k) plans are usually not liquid. However, in many cases, you can borrow up to $50,000 from your plan. Yet borrowing comes with strict repayment terms. On the other hand, IRAs are completely liquid. When you withdraw money, though, you will be taxed immediately, and if you’re under 59 ½ years old you’ll have to pay a 10% penalty.
The safety of qualified plans is not very high. With 401(k) plans, you don’t have unlimited access to any asset you want. The plan administrator decides which assets will be available to employees. IRA plans may be safer than 401(k) plans, but it depends on the type of assets that you choose.
In general, 401(k) plans tend to be expensive. The plan administrator decides which funds will be available, and they’re not always the least expensive funds. You also have to pay administrative fees for 401(k) plans. Most people don’t know what the fees are because they’re typically hidden in the fine print. The expenses for IRAs tend to be lower—there aren’t any administrative fees if the plan is self-directed. However, the expenses of the assets themselves will still be present.
Rate of Return
The rate of return for 401(k) plans depends on the underlying assets that your employer makes available. Yet, since many employers provide employee matching the rate of return can be high. Employers who offer employee matching will usually match 2-6% of your funds. The average tends to be around 3%. There is no employee matching with an IRA plan, so the rate of return depends on the underlying assets in the account. Therefore, the rate can vary wildly from plan to plan.
The tax efficiency depends on whether you have a Roth 401(k) or IRA or you have a regular 401(k) or IRA. When you withdraw money from regular plans, you pay ordinary income taxes. When you withdraw money from a Roth plan, though, you don’t have to pay taxes. With both plans, your money will grow tax-free. Many people find Roth plans attractive since they expect taxes to increase in the future. However, if you earn more than $200,000 you’re ineligible to participate in a Roth IRA. IUL plans are a popular alternative for investors who make more than $200,000.