The terms 401(k) and individual retirement account (IRA) are bandied about quite a bit when discussing retirement planning, but what are the actual differences between the two?
IRA vs. 401(k)
The main distinction is that a 401(k) — named for the section of the tax code that discusses it — is an employer-based plan. An IRA is an individual plan. But there are other differences as well.
Both 401(k)s and IRAs are retirement savings plans that allow you put away money for retirement. You may begin taking distributions from these plans at age 59½.
There are two main types of IRAs: Roth and traditional.
With a traditional IRA, you don’t pay taxes when you make contributions (and in fact may benefit from a tax deduction) because the taxes are paid only when you withdraw the money.
With a Roth IRA, you pay the taxes up front and any gains accumulate tax-free.
In addition, with a traditional IRA and 401(k), you are required to start taking minimum distributions at age 72 (or if you turned 70½ in 2019 or before), but with a Roth IRA there is no requirement to take minimum distributions.
Participation in 401(k)s and IRAs
In order to have a 401(k), you must work for an employer that offers this type of plan as part of its benefit package. Because it is a benefit, your employer may limit which employees may join the plan. Contributions are usually made through deductions from your paycheck.
Any individual who is younger than 72 and earning an income can set up an IRA through a bank or other financial institution. You as an individual are responsible for establishing the plan and contributing to it.
Annual Contributions to 401(k)s and IRAs
Employees can contribute up to $22,500 (in 2023) to a 401(k). Participants who are 50 or older can make an additional $7,500 contribution to a 401(k). In addition, employers may match all or part of the contributions of their employees.
Most individuals can contribute a maximum of $6,500 (in 2023) to an IRA, or an annual total of $7,500 if you are 50 or older. Some of the contributions may be tax-deductible, depending on your income and marital status.
Investments
401(k)s offer a limited number of investments that are usually mutual funds.
With an IRA, you may have a broader range of investment opportunities, including stocks, bonds, and real estate.
Can I Borrow From an IRA or 401(k)?
Employees usually can take a loan or hardship withdrawal from a 401(k), while loans are generally not permitted with IRAs.
You may be able to take out money from an IRA on a limited basis if you return it to the IRA or another IRA within 60 days. (Check out information on IRA rollover rules on the IRS website.)
401(k) and IRA Beneficiary Rules
Under federal law, your spouse is automatically your beneficiary when you sign up for a 401(k) even if you listed someone else. If you wish to name someone other than your spouse as beneficiary, your spouse needs to consent in writing. If you are single, you will need to name a beneficiary.
With an IRA, you can designate whomever you want to be your beneficiary without needing spousal consent.
Get more information on retirement planning.
Connect with elder law atttorney near you to learn more.
Subscribe to the Knowledge Bank.
