What is the difference between an IRA and 401(k)?

If you work for a company that offers a retirement plan, it is likely that it is offering a 401(k) plan. However, a 401(k) is not the only type of retirement plan available to you. There are several options out there, but one of the other main retirement planning options besides the 401(k) is an IRA.

So the question becomes, what is the difference between the two, and how do you decide which to use?

The difference between an IRA and 401(k)

Both of these retirement accounts offer tax advantages for Americans saving for their retirement. However, the methods for which you receive tax advantages differ between them. 

401(k):

With a 401(k) account, you make contributions with pretax dollars. Usually, this is an amount determined by you to be withheld automatically from your paycheck. This is advantageous for lowering your tax liability for the current year, but you will be responsible for paying taxes when making withdrawals in your retirement. 

A 401(k) can only be opened through an employer. If you own and operate a small business, you can open a solo 401(k) account.

401(k)s can be advantageous because employers often offer matching contributions. Some match dollar for dollar what you contribute until you reach the annual limit of $19,500 (or $26,000 if you are over the age of 50). Others match 50 cents to the dollar. Each company’s matching scheme is different, so take a moment to review your employer’s 401(k) plan and how it can benefit you.

Withdrawals can be made once you are 59 ½ or older. Generally, early withdrawals are subject to a penalty fee of 10%, but the CARES Act of 2020 makes some exceptions to the current early withdrawal penalty.

IRA:

An IRA (individual retirement account) can be opened on your own, regardless of employment status. This is a good option for those whose employers do not offer a 401(k) plan or who wish to further supplement their retirement savings. IRA accounts have a smaller annual contribution limit of $6,000, or $7,000 if you are age 50 or older. However, with an IRA, you have more flexibility in your investing and savings options.

There are different types of IRAs that take different approaches to tax advantages. With a traditional IRA, you make contributions with pretax dollars like in a 401(k). You pay taxes on your withdrawal. With a Roth IRA, you make contributions with post-tax dollars. This means your contributions for the current year are still taxable, but you will not have to pay taxes on them when you make withdrawals at your eligible retirement age. 

Talk to a ProVise CFP® professional about choosing your retirement path

With so many options for saving for your retirement, you might start feeling a little lost or confused. Our team at ProVise Management Group is here to help. Our financial professionals can act as your guide in the confusing financial landscape to help you save and reach your retirement goals. 

Our CERTIFIED FINANCIAL PLANNER™ professionals can get to know you and your current financial circumstances, goals, risk tolerance and personal values to help you develop a plan that works for you. We can also create a written plan for you at a fiduciary standard of care. All our written plans come with an unconditional money-back guarantee. If you are unhappy with your written plan, you can return it to us, and we will refund 100% of the fee paid.

Are you ready to talk to a professional about planning for your retirement? Contact ProVise today to schedule a complimentary consultation.