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5 Things You Can Do With an IRA That You Can't With a 401(k)

Nov 20, 2023

IRA or 401(k)? Know the key differences between these two popular retirement plans to ensure you are saving in the right account.

Individual retirement accounts (IRAs) and 401(k)s share many similarities. Both are retirement plans; both can help lower your tax bill today, provide tax-deferred growth, and provide an income source in retirement.


There are, however, many differences between IRAs and 401(k)s. Some are benign and won't have much impact, but other contrasts can make one type of account far superior to the other in particular situations. With that in mind, we'll explore five things you can do with an IRA that you can't with a 401(k).


1) Make a Qualified Charitable Distribution

Qualified charitable distributions allow IRA owners and IRA beneficiaries age 70½ or older to send up to $100,000 from their IRA account directly to a charity without including any of that amount in their income.


You won't get a charitable deduction if you make a qualified charitable distribution. However, by never adding the income to your tax return in the first place, it often still results in a lower tax bill than if you had taken a "normal" IRA distribution and made a "regular" charitable contribution. In no case would your tax bill be higher. 


As a bonus, you can use your qualified charitable distribution to offset a portion or all of your required minimum distribution after your required beginning age.


2) Take a Penalty-Free Distribution for Higher Education Expenses

Distributions taken from a retirement account before age 59½ are generally subject to income tax and an additional 10% early distribution penalty. The law does, however, provide for several exceptions to this rule. One such exception is available if you use your IRA to pay for higher education expenses (i.e., college tuition, books, required supplies) for yourself or other designated family members, such as your children. Again, this exception is only available if you take money from an IRA before age 59½.


These exceptions do not, however, apply to 401(k) accounts, and if you try to withdraw funds early, you will wind up with a bigger tax bill than you bargained for. Some brilliant and well-educated people, including lawyers and CPAs, have gone to tax court to argue this point, and they have yet to walk away the victor: don't make the same mistake they did.

3) Take a Distribution When You Want

The purpose of a retirement account is to save money for just that: retirement.


However, life happens, and sometimes people need access to their funds sooner than planned. If you are still working for the company sponsoring your 401(k) and need some additional funds, you're at the mercy of your plan's rules and, to an extent, the Tax Code when accessing your money. Fund access is typically minimal, especially if you're still under 59½. In such cases, you may be able to take a loan from your 401(k), and you may be able to take a hardship distribution, but neither of those options is guaranteed to you legally.


In contrast, if you have an IRA, you can typically take a distribution from your account whenever you want, with no restrictions under the law whatsoever. Of course, as noted above, if you take a distribution from your plan or your IRA before age 59½, you will generally owe income tax and a penalty, but if you really need those funds and there is nowhere else to turn, what choice do you have?


4) Aggregate RMDs Between Multiple Accounts

Today, it's not uncommon for people to accumulate several 401(k)s or similar plans over time through their work with different employers. Similarly, many retirees have more than one IRA account (some even have ten or more)! 


If you have more than one 401(k) and you're age 73 or older, you must calculate the RMD (required minimum distribution) for each 401(k) plan separately and take those RMDs from each plan individually.


In contrast, if you have more than one IRA and you're 73 or older, an RMD must be calculated for each IRA; however, you can combine (or aggregate) the RMDs and take them from any IRA or combination of IRAs you choose without a penalty.


If you accidentally took the same approach with your 401(k) plans, you'd be subject to a 50% penalty for each plan from which you did not take the appropriate distribution.


5) Avoid Withholding

Paying your taxes is not optional; it's a requirement. You may, however, have a very low or even non-existent tax bill after applying all of your available deductions, exemptions, credits, etc. Alternatively, you may have withholdings from other sources, such as a pension, or make estimated tax payments sufficient to cover your tax bill. In such cases, there's no reason to have any further amounts withheld from your retirement account distributions. Doing so would give the government a tax-free loan until you filed your taxes and received your refund.


If you have an IRA, you can avoid this entirely; when you take a distribution from your IRA, you can opt-out altogether of withholdings. This, however, is different with a 401(k). In general, distributions from 401(k)s eligible for rollover are subject to mandatory withholding of 20%. There is no opt-out provision. After all, it isn't called "strongly suggested withholding."


So there you have it: five things you can do with an IRA that you can’t do with a 401(k).


Does that mean IRAs are better than 401(k)s? No, of course not. They're different. For some people, IRAs are better, while others will benefit more from a 401(k). 

Work With Clayton Financial Group

At Clayton Financial Group, we help our clients achieve their plans for life and take their growth and security seriously. We are an independent boutique advisory firm with national coverage and decades of industry experience.


If you're looking for help with investment planning, tax planning, risk management, estate planning, and more, look no further: let's connect today.

11 Financial Tips to Make Caregiving Easier

08 May, 2024
Becoming a caregiver to a family member or loved one may occur at some point in your life, whether due to unexpected circumstances or old age. If you already are a caregiver or know someone who is, you may have some stories about how overwhelming it can be—emotionally and otherwise. Caregiving requires love, time, and patience, but the financial aspect of caregiving often doesn't get the proper attention it needs. Discuss this side of caregiving with your financial professional, who can offer you various resources and guidance to make things easier. These 11 tips can also help you manage your loved one's finances more effectively. 1. Talk About It Now Before It’s Too Late We must prepare for the unexpected, which means having a financial discussion with the person you are caring for in advance. While discussing money with them can seem complicated, it doesn't have to be. As a current or future caregiver, you need answers to some key questions. Let your loved one know that it's in their best interest to address these things now: Has your loved one saved money? If so, how much? What's their source of income? Do they have investments or insurance policies? Who is their financial professional/attorney/CPA? Do they want to live in an assisted living home or prefer to live at home? Have they planned for elder care (or can they pay for it)? Do they have long-term care insurance? Discussing these things when the aging parent is healthier and able to make decisions can make it easier for you to take action when the time comes. 2. Review Estate Planning Documents Find out if your loved one has prepared estate planning documents, and ensure that their will and power of attorney are current. A living will and health care proxy are critical estate planning documents to take care of immediately. They entail how you should handle medical treatment while your loved one is still living but can no longer express their health care wishes or make medical decisions on their own. Again, the best time to do this is while all parties are healthy and of sound mind. But if that time passes, it should still be a priority; it's never too late to get these in order. 3. Keep Financial Documents Organized and Accessible Necessary documents, such as wills, powers of attorney, investment statements, insurance policies, and bank account statements, should be reviewed, updated, and kept in a secure, accessible place. Ensure they are all kept together in one place with relevant passwords. 4. Know What’s Important to Your Loved One Generally, a caregiver's top priority should be to do what their loved one wants. For that reason, take the time to talk with them about their preferences for receiving care. Is it important to them to not be a burden on their children? Are they okay with living in an assisted living or nursing home? Would they rather live at home? Another option is to ask your loved one to write a letter expressing their desires and reasons. While living wills or health care proxies often cover wishes and instructions, they don't cover feelings. A personal letter can remind you of the sentiment behind your loved one's wishes. While you, as a caregiver, may not be able to fulfill all their wishes, you can still make the best possible decisions for them. Knowing what your loved one wants also helps you understand and empathize with them. 5. Seek Professional Advice When planning for your loved one, you should seek two types of professional advice – financial and legal. Ask your financial professional to recommend an attorney for legal consultation (and a tax professional for tax advice, if necessary).

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When Should I Start Planning My Estate?

11 Aug, 2023
There are many misconceptions when it comes to estate planning. People miss out on the chance to preserve wealth in their family because they think they are too young to start planning an estate or need more assets. The reality is that any of us can pass unexpectedly, and having a plan helps our loved ones honor our legacy and navigate through the period after our death with more direction. Let's discuss the difference between an estate and a will, when to start planning, and items to consider. Estate vs. Will: Understanding the Differences Estate plans and Wills seem interchangeable, but they serve different purposes. A Will outlines your wishes for distributing your assets after your passing, while an estate plan encompasses a broader spectrum of considerations. An estate plan can include a Will, but also covers aspects like healthcare directives, guardianship for minor children, and strategies for minimizing taxes. When to Start Estate Planning Many individuals wonder when the right time is to start estate planning. The answer is simple: as early as possible. Life is unpredictable, and waiting for significant life events to trigger estate planning can lead to complications. If you're getting married, becoming a parent, acquiring substantial assets, or starting a business, it's time to create an estate plan. Don't delay; the peace of mind that comes with knowing your affairs are in order is invaluable. How Often to Update Your Estate Plan Creating an estate plan is not a one-time endeavor; it's an ongoing process. Changes in your life circumstances, financial situation, and even laws and regulations can affect the effectiveness of your plan. Reviewing and updating your estate plan every 3-5 years or after significant life events is recommended. Keeping your plan current ensures that it accurately reflects your wishes and the current legal landscape. Accounts and Financial Assets Your estate plan should encompass all your financial assets, including traditional accounts and digital holdings. Documenting your account information and login credentials is essential for your beneficiaries to access these assets. Failing to account for digital assets can lead to valuable resources being lost or inaccessible. Property and Heirlooms The sentimental value attached to specific properties and heirlooms can complicate estate planning. Strategies like gifting, trusts, and detailed instructions ensure these items are passed down smoothly without causing family disputes. Balancing financial implications with emotional connections is vital to preserving your legacy and your family's harmony. Business Succession Planning Business owners have unique considerations when it comes to estate planning. Without a proper business succession plan, the future of your enterprise could be uncertain. Addressing questions of who will take over, how ownership will transition, and how the business's stability will be maintained is crucial. A well-thought-out business succession plan protects not only your legacy but also the livelihoods of your employees.

The Benefits of a 529 Plan

14 Jul, 2023
What is a 529 Plan? A 529 Plan is a tax-advantaged savings plan that encourages individuals to save for qualified education expenses. Administered by states or educational institutions, it provides a structured approach to funding education, whether it's for your children, grandchildren, or even yourself. This investment vehicle offers attractive benefits, making it an appealing choice for many families. Tax Benefits One of the key advantages of a 529 Plan is the array of tax benefits it offers. First and foremost, your contributions grow tax-free over time, allowing your savings to compound and potentially grow significantly. Additionally, withdrawals made for qualified education expenses are tax-free, making it a highly tax-efficient way to fund education. Some states offer additional tax benefits, such as deductions or credits for contributions to a 529 Plan. These tax advantages can maximize your savings and boost your educational funding strategy. Financial Aid Considerations When planning for education, financial aid is a critical aspect to consider. Many families worry that having a 529 Plan might negatively impact their eligibility for financial aid. However, the impact is relatively low compared to other types of accounts. The assets in a 529 Plan are generally treated as parental assets, with a lower impact on financial aid calculations. So, by saving in a 529 Plan, you can secure your educational funding while minimizing potential disruptions to your financial aid prospects. Transferability and Control A 529 Plan offers exceptional flexibility in transferring funds between beneficiaries within the same family. Suppose one beneficiary decides not to pursue higher education or there are remaining funds after one beneficiary completes their education. In that case, you can easily transfer the funds to another eligible family member without tax consequences. This transferability ensures that your savings are utilized effectively and that you retain control over the funds until they are needed. Additionally, the SECURE Act 2.0 made it possible for $35,000 to be transferred to a Roth IRA if a 529 beneficiary does not need their funds for education. However, the 529 Plan must have been in existence for at least 15 years prior to the rollover for this option. Further, any 529 contributions made within the last five years before the rollover are not eligible. If the 529 Plan meets this requirement, then contributions can be made annually to the beneficiary's Roth IRA up to the Roth's maximum amount each year. The contributions are limited to the annual Roth ceiling, and up to a lifetime max of $35k (i.e. the full $35k can not be transferred into the account at one time). Qualified Education Expenses To take full advantage of a 529 Plan, it's essential to understand what expenses qualify. Qualified education expenses typically include tuition, fees, books, supplies, and equipment required for enrollment in eligible educational institutions. These expenses can vary depending on the educational institution and program. Importantly, this can encompass both undergraduate and graduate programs. Room and board expenses may also qualify if the student is enrolled at least half-time. It's essential to familiarize yourself with the specific guidelines to ensure you maximize the benefits of your 529 Plan. Funds are also available for K-12 education up to $10K per year. This versatility ensures that your savings can be utilized for various educational needs, providing peace of mind and financial stability. The opportunity to use 529 Plans for K-12 tuition expenses became available in 2018, and each state has additional requirements to look in to. Income Tax Breaks Besides the federal tax benefits, many states offer income tax breaks for contributions to a 529 Plan. Depending on your state, you may be eligible for deductions or credits for your assistance. These state tax advantages further enhance the tax benefits of a 529 Plan. Additionally, the tax-free growth and tax-free withdrawals for qualified education expenses at the federal level make this investment vehicle highly attractive from an income tax perspective.
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