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IRA and 401k- What’s the difference?

IRA and 401k- What’s the difference?

May 30, 2024

Retirement accounts are some of the most important investment vehicles an individual can use to help them build a nest egg for when their working years are over. There are many different forms of retirement accounts, including an IRA, 401k, and 403b among others.

In this week’s blog, we wanted to focus on some of the similarities and differences between two very common retirement accounts, an IRA and a 401k account.

First let’s start with the main difference. An IRA or Individual Retirement Account is exactly what it sounds like, a retirement account that can be created by you. A 401k account does not have the same ability. 401k's are in the family of employer sponsored plans which means that your employer would have to set up the retirement plan as part of their benefit package to their employees.

401k plans are generally set up for employees that work in for-profit businesses whereas not-for-profit businesses would be able to set up a 403(b) plan and governmental agencies would set up a 457 plan.

Regardless of that fact, both retirement plans can help to play a key role in building your wealth during your working years.

Another key differentiating factor between a 401k account and an IRA is the contribution limit that an individual can invest during an annual period. Yes- both accounts have contribution limits, and they vary quite drastically.

For a Traditional or Roth IRA, the current contribution limit for 2024 is $7,000 with an additional $1,000 in catch-up contributions for those over the age of 50. This catch-up contribution was put in place to help those who are closer to retirement invest more money.

For a 401k account, the annual contribution limit for 2024 is $23,000 with an additional $7,500 in catch-up contributions for those over the age of 50. These contribution limits generally increase over time. For example, in 2023, the contribution limit for an IRA was $6,500 and for a 401k was $22,500.

Now, let’s talk about the investment options in each of these accounts. In an IRA, the investment options are generally much more flexible than those of a 401k plan. An IRA allows an individual to invest in stocks, bonds, ETFs, Mutual Funds, among other types of investment vehicles.

For a 401k account, you are generally limited to picking from a Mutual Fund line-up which is chosen by your employer or the Financial Advisor of record on the plan.

Let’s move onto account types now. For IRA’s and 401k’s, you may be able to contribute your money into either Roth or Traditional (Pre-Tax) accounts.

A key differentiating factor between Roth contributions in an IRA and 401k is your annual income. In a 401k account, there is no annual income restriction on contributing to it with “Roth” dollars.

However, depending on your annual income, you may not be eligible to invest in a Roth IRA. Per the IRS website, in 2024 “the income phase-out range for taxpayers making contributions to a Roth IRA is increased to between $146,000 and $161,000 for singles and heads of household, up from between $138,000 and $153,000. For married couples filing jointly, the income phase-out range is increased to between $230,000 and $240,000, up from between $218,000 and $228,000. The phase-out range for a married individual filing a separate return who makes contributions to a Roth IRA is not subject to an annual cost-of-living adjustment and remains between $0 and $10,000.” *

A main similarity between a 401k and an IRA is that both accounts allow penalty-free withdrawals starting at age 59 1/2. If you withdraw funds prior to age 59 1/2 and the reason for withdrawal is not on the list of exemptions, you will be faced with a 10% penalty in addition to any potential taxes owed on the money. 

Regardless of the differences, the bottom line is, saving for retirement is extremely important during your working years. Taking advantage of any form of retirement account you are eligible for; can help you build confidence in the next phase of your life.

Do you have questions you would like us to discuss here? Click this link to let us know and we hope you found this helpful!

The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual.