When it comes to retirement vehicles, the choice often becomes 401(k) vs IRA. Some employers offer a retirement option, like a 401(k). As an employee, you have a choice between selecting an employer option or establishing your own IRA.
But what’s the difference, really? How do they work? What are the rules? And if you have the choice, which should you pick? Be aware there are other options too – 457 (state gov employees), SEP (Small Employer Plan) and Simple IRAs.
We’d like to give you a comparison on some of the major points of difference between IRAs and 401(k)s. That way, when faced with the choice of where to put your retirement savings, you can make the right choice for you.
401(k) vs IRA vs Roth
One big point of confusion that investors often face is differentiating between 401(k)s, IRAs and Roth IRAs. While there are a number of differences that we will explore below, the biggest difference is between 401(k)s and IRA products in general.
As Investopedia explains, “A 401(k) is a tax-deferred retirement savings account employers offer their employees. Employees contribute money to their account via elective salary deferrals, meaning a percentage of their salary or a dollar amount is withheld and contributed to the 401(k).” This means that a 401(k) is an employment benefit, and employers generally will contribute funds to the account as a part of the benefits package.
An IRA (Individual Retirement Account), on the other hand, is a retirement investment option that you can start on your own. There are several types that you can choose from, and your bank can advise you on the merits of each, but for our purposes here we’ll break them down into Traditional and Roth IRAs.
Contributions to a traditional IRA are usually pretax, and are tax deductible. Investopedia says, “Earnings and returns grow tax-free, and you pay tax on withdrawals in retirement. Contributions to a Roth IRA are made with after-tax dollars, meaning you don’t receive a tax deduction in the year of the contribution. However, qualified distributions from a Roth IRA are tax-free in retirement.”
401(k) vs IRA contribution limits
Both 401(k) and IRA retirement accounts have annual contribution limits.
CNBC says, “For 2022, you can put up to $20,500 in a traditional 401(k), up $1,000 from 2021. The 50-and-over crowd is allowed an extra $6,500 as a “catch-up” contribution, for a total of $27,000. Employer contributions do not count toward these limits.” Including employer contributions, the limit is “$61,000, and it’s $67,500 for participants age 50 or older”
For IRA accounts, the IRS has set the limit at $6,000.
The limits on both types of account generally change every year.
401(k) vs IRA rollover
Moving your funds from a 401(k) to an IRA is called rollover. You can make this choice if you leave an employer or if you want more control of your investments. By following specific rules, you can often roll your investment account over without a tax penalty.
401(k) vs IRA withdrawal rules
Both IRAs and 401(k)s have strict withdrawal rules if you want to avoid early withdrawal penalties. Generally speaking, both require you to be 59 ½ years old in order to avoid a tax penalty. Some accounts may allow for early withdrawal without penalties, if you leave a job over 55. And some accounts require you to start withdrawing money at age 72. Some 401(K)s have a loan option. This allows you to borrow your money and pay it back, with interest, over time. As you pay the loan back, you’re increasing your fund balances.
We hope that this helps you to choose between retirement plan options.
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