What Are the Key Differences Between IRA and 401(k)?

If you have been looking for a retirement savings plan, you might have come across two terms: IRA and 401(k). Both terms refer to separate savings plans that allow you to contribute a part of your income towards your retirement fund while offering tax incentives like lower taxable income. While both types of retirement accounts have their pros and cons, the key difference exists in the way they function. You start a 401(k)-retirement account through your company, while the IRA (Individual Retirement Account) can be opened individually without the involvement of your employer.There are several important differences between IRA and 401(k)to be aware of when properly selecting your retirement plan.

IRA and 401(k)

An IRA is a retirement savings plan that allows an individual to open a savings account for themselves. It allows individuals to save on their own without matching contributions from their employers. On the other hand, the 401(k) allows employees to contribute a set percentage of their income to their account; the employer will match these employee contributions up to a limit. You can open both at the same time, although it is advisable to make an informed decision.

The Key Differences

Contribution Limits

IRAs allow a maximum employee contribution of $6,000, as of 2022. For individuals aged above 50, annual catch-up contributions are allowed up to $1,000. The SEP-IRA (Simplified Employee Pension Plan) allows a higher contribution of up to 25 percent of your annual income or $61,000, whichever is less.401(k) accounts allow individuals to contribute up to $20,500 per year, as of 2022. Catch-up contributions for people older than 50 years are allowed up to $6,500. Employers usually match a set percentage of their employees’ annual contributions. The total amount contributed to an employee’s account per year cannot exceed $61,000 (excluding catch-up contributions) or $67,500 (including catch-up contributions).

Withdrawals

Both IRA and 401(k) accounts allow individuals to withdraw money from their accounts once they reach retirement age (59.5 years). In the case of IRAs, withdrawals before this age incur a 10 percent tax penalty if the individual does not qualify for a hardship withdrawal. You can not borrow a loan against your IRA account balance.On the contrary, a 401(k) account has similar stipulations for withdrawals concerning age. However, an individual can make a hardship withdrawal or borrow a loan against their 401(k) account, the repayments of which get deducted from their paychecks.

Investments

Although IRAs have lower contribution limits compared to 401(k) retirement plans, they generally offer a larger selection of investment options. A 401(k) is ideal for people who are not too particular about their investment options, since most 401(k) plans are limited to the investment options chosen by the employers, such as stocks or bonds.

Conclusion

Both IRA and 401(k) plans are excellent retirement savings options that offer tax benefits to people looking to save for their post-retirement lives. If your employer offers a 401(k) plan, you should carefully weigh the pros and cons of these plans to access the full range of benefits offered by each retirement plan. Some key considerations include annual contribution limits, investment options, withdrawals, and more.