What are the differences between a 401K and an IRA?
A 401(k) is an employer-sponsored retirement plan and an IRA is an Individual Retirement Account. Your IRA is yours; it does not change no matter where you work. A 401(k) has to stay with the employer. It can be rolled over to most 401(k)s or into an IRA but a 401(k) is employer specific, unlike an IRA.
As far as tax benefits and restrictions, they are similar. For traditional 401(k)s and IRAs, money goes is pre-tax and qualified distributions come out taxed as ordinary income with similar age restrictions. Other differences/similarities:
- IRAs have income restrictions, 401(k)s do not
- 401(k)s can have loan provisions, IRAs do not
- An employer can contribute to a 401(k), not an IRA
- Both have Roth options
- IRAs can invest in most anything (including real estate), 401(k)s are more restrictive
If you can, having both is an awesome option. My blog has a series on small-business, employer-sponsored plans that might be helpful:
Mark Struthers CFA, CFP®
Some of the main differences are:
- A 401(k) plan is an employer-sponsored plan therefore you must work for the company in order to participate in the 401(k). In most cases anyone under the age of 70.5 who earns income can participate in an IRA.
- The 401(k) plan usually has better creditor protection than an IRA since it is an employer-sponsored investment plan.
- 401(k) plan contributions are usually made through payroll deductions. An IRA contributions usually are done by the individual writing the check and depositing in the IRA.
- A 401(k) Plan can offer loan privileges. An IRA does not have loan privileges.
- A 401(k) Plan can have an employer match provision. An IRA does not
- Contribution amounts are higher for a 401(k) ($18K for 2017). An IRA has a contribution amount of $5,500 (not including catch up)
- The catch up amount in a 401(k) is $6,000 in 2017. An IRA catch up is $1,000 in 2017.
- The investment options in a 401(k) are usually more limited than an IRA
A 401(k) comes from your employer. Typically, you have to pick investments from a narrow list of choices. The best ones have an employee matching program where the company will match what you put in. Always take the match, it's free money.
An IRA is completely independent. You can open them yourself for free and you can decide from thousands of securities how you would like to invest. Usually when you leave a company, you "rollover" your 401(k) into an IRA.
Both are tax-deferred retirement accounts, meaning you can invest tax-free until you take it out after age 59 1/2.
A traditional IRA and 401(k) are similar in terms of how they are treated for taxes. The main differences are contribution limits, access to funds, and eligibility.
Both the IRA and 401(k) are retirement accounts and the IRS provides special tax benefits for money contributed and held in these respective account types. Funds invested in both will grow tax deferred, and typically investors receive an income tax deduction for the tax year in which they make contributions. Your ability to receive a tax deduction for contributions to an IRA depends on your tax situation, here is information about deductions for IRA contributions from the IRS.
You can contribute more to a 401(k) each year than you can to an IRA and you can contribute to both in any given year. Furthermore, if you are over the age of 50, you can make additional “catch up contributions”. Below are the 2016/2017 annual personal contribution limits published by the IRS:
|With Age 50+ Catch Up||$6,500||$24,000|
If you withdraw funds from an IRA or 401(k) before age 59 ½, the IRS will assess a 10% tax penalty in addition to income taxes owed on the funds disbursed. Some 401(k) plans may offer loans, which allows you to access a portion of your 401(k) account in the form of a loan, which you are expected to pay back to yourself. If you don’t pay it back, it will be considered a withdrawal and you may be subject to the early withdrawal penalty based on your age at the time of taking the loan. IRA accounts do not allow loans.
The key factor of being able to contribute to a 401(k) is having access to one. Anyone can setup an IRA for themselves, but a 401(k) is a group retirement plan setup by an employer. If you are an entrepreneur or a small business owner, your business can setup a plan for you. If you are an employee, it would be up to your employer group to offer a 401(k) plan.
There are many other differences in terms of maintaining a 401(k) which is subject to ERISA and entails all sorts of additional reporting, testing, and compliance each year. An IRA is much more simple to setup and does not involve any of this additional reporting or annual administration.
A 401(k) account is part of an employee's benefit package offered by his/her employer. The employee is able to contribute funds from income and the employer, in many cases, will match a portion. For a traditional 401(k) account, it is tax-deferred, making it similar to an IRA. An IRA, on the other hand, is an account that is separate from the employee's benefit package. It may have been funded by a 401(k) from a previous employer, but the IRA is completely separate from any employer or benefit package. Oftentimes, 401(k) accounts have a limited number of investment selections available. An IRA can have a wide variety of choices depending mainly on the broker-dealer holding the account.