When it comes to retirement and savings, it’s hard enough to free up extra money in order to contribute to the future, but it’s necessary. So how do you choose where to put your hard-earned money? The two most common vehicles used by most people nowadays is 401(k) plans and Individual Retirement Accounts. The difference between a 401(k) and IRA is that an employer establishes a 401(k) and an IRA is set up by individual investor many people want to know what are the differences between an IRA vs. 401k. Here are the significant differences:
IRA v. 401k Simply Put
A traditional IRA is available to any person who is below the age of 70 ½ and has earned income. A 401(k) is only available to employees in a company that offers a 401(k) plan with contributions that are made by the employer to the employee’s 401(k) account. An individual makes all contributions to an IRA. Both plans offer significant tax deduction benefits, and a 401(k) has a significantly higher maximum contribution level when compared to a traditional or Roth IRA. The main advantage of a 401(k) account that employers can match employees’ contributions. This is why the contribution limits of 401(k)s are three times higher than those of IRAs. Contribution limits are also higher than the maximum contribution allowed for IRA accounts.
An IRA offers a lot more flexibility because most accounts will allow owners to make a withdrawal at any time. With the 401(k), employees can only access their savings after they have reached a distribution event such as:
– Reaching age 59 ½
– No longer working for the employer who is sponsoring the plan
– Request for a loan or hardship distribution during employment
There are also different rules on taxation of withdrawals depending on which plan you have. When you withdraw from an IRA, you will have to pay income tax on the money that was withdrawn during the year when the withdrawal was made. If you make the withdrawal before the age of 59 ½, you will be subject to a 10% early distribution tax unless there is some penalty exception.
With a 401(k), employees are required to pay income tax on the employer contributions, pretax employee contributions, and earnings withdrawn from the 401(k) during the year that the withdrawal was made. Just like Iraq IRA, taxable withdrawals are subject to a 10% early distribution tax if the withdrawal was made under the age of 59 ½.
Cost can significantly vary depending on what type of 401(k) plan you have. It is a good idea to look at your 401(k) plan documents and find out how much you pay in fees annually if you find out that you are in a high-cost plan, you may want to look for an IRA that may cost a whole lot less depending on your situation.
Choose the Best Option
Both an IRA and a 401(k) account are excellent options for savings. When combined, they help individuals increase their financial portfolio significantly. Take more time to learn the differences between a 401(k) and an IRA to help you achieve greater financial success.