An IRA (Individual Retirement Account) and a 401(k) are both types of retirement savings plans that allow individuals to set aside money for the future. However, there are some significant differences between these two types of plans.
One of the main differences between an IRA and a 401(k) is the way that they are funded. An IRA is typically funded by an individual using after-tax dollars, while a 401(k) is funded with pre-tax dollars that are taken directly out of an individual’s paycheck. This means that contributions to a 401(k) are tax-deductible, while contributions to an IRA are not.
IRAs Are Self-Administered
Another difference between an IRA and a 401(k) is the way that they are administered. An IRA is typically self-administered, which means that the individual is responsible for choosing and managing their own investments. A 401(k) is typically administered by an employer, and the individual has a limited selection of investment options to choose from.[1]
There are also differences in the contribution limits for these two types of plans. The contribution limits for an IRA are generally lower than those for a 401(k). For example, in 2023, the contribution limit for an IRA is $6,500 per year for individuals under the age of 50, while the contribution limit for a 401(k) is $22,500 per year for individuals under the age of 50.[2]
IRAs and 401(k)s Can Be Taxed Differently
Another difference between an IRA and a 401(k) is the way that they are taxed. Withdrawals from a 401(k) are taxed as ordinary income, while withdrawals from a certain kind of IRA called a Roth IRA may be withdrawn from tax-free. Additionally, with a 401(k) and traditional IRA, individuals are required to begin taking minimum distributions at age 73 (as of the recent SECURE Act 2.0), while there is no such requirement for a Roth IRA. [3]
IRAs and 401(k)s Are Often Used Differently
Finally, there are also some differences in the way that these two types of plans are used. An IRA is typically used as a supplement to other types of retirement savings, such as a pension or Social Security, while a 401(k) is sometimes a larger source of retirement income for people given employer matching plans and automatic contribution programs.
In conclusion, while both an IRA and a 401(k) are useful tools for saving for retirement, they have some key differences. Understanding these differences can help you choose the right type of plan for your specific needs and financial situation. If you have questions about your financial situation and retirement plan, feel free to call us for a complimentary review of your financial picture.
[2] https://www.irs.gov/newsroom/taxpayers-should-review-the-401k-and-ira-limit-increases-for-2023
[3] https://www.forbes.com/sites/jamiehopkins/2022/12/22/5-rmd-changes-looming-with-likely-passage-of-secure-20-act/?sh=732fa68d66e9
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