401(k) vs. IRA: What’s the Difference?

A 401(k) and an individual retirement account (IRA) can both serve as smart options when planning for retirement. However, each account type comes with its own set of rules and requirements. If you’re unsure of which account is right for you, or you’re interested in opening both types of accounts, we’re here to break down the differences between the two so you can make an informed decision.

What is a 401(k) account?

Many employers offer their employees a 401(k) employer-sponsored retirement plan. Individual business owners without employees can also open a 401(k) called a Solo 401(k). A percentage of an employee’s pre-tax income is placed into their 401(k) account automatically through payroll deduction, reducing their gross total income.

Participants can also make a larger contribution to a 401(k) account than an IRA account. The contribution limit in 2023 is $22,500 or $30,000 if you’re age 50 or older.

The funds in this account are invested, often in funds like mutual funds, and can grow over time; these earnings are also tax deferred. The participant won’t pay taxes on the account until the time of withdrawal. Account distributions will be taxed based on the recipient’s income tax rate at the time of distribution.

Roth 401(k)s

Some employers offer their employees the option of a Roth 401(k), which is like the traditional 401(k) with the exception that contributions are post tax. This means that when the participant makes qualified withdrawals of their Roth funds, they will be tax-free.

Benefits of 401(k)s

The benefits of enrolling in a 401(k) plan include but are not limited to:

• Employers may provide matching contributions to employee 401(k) accounts.
• A 401(k) plan allows for high annual contributions, $22,500 in 2023.
• Employees can make catch-up contributions at the age of 50 and over.

What is an IRA account?

A traditional IRA is another type of tax-deferred retirement account. An individual sets up this account through a bank or a brokerage.

IRA contribution limits are lower than that of a 401(k): $6,500 for those under 50 and $7,500 for those age 50 or over. IRA contribution limits may be further limited based on your income.

If you choose to enroll in a Roth IRA, you will make contributions using post-tax dollars. A Roth IRA will not provide a yearly tax deduction; however, you will be able to make qualified withdrawals funds at the time of retirement tax-free.

Benefits of enrolling in an IRA include but are not limited to:

• You can open this account as an individual.
• You can choose to open an account at any brokerage, bank, or investment firm.
• You can contribute up to $6,500 per year and $1,000 in catch-up contributions (2023)

How are 401(k)s and IRAs Similar?

The good news is that both 401(k) accounts and IRAs allow you to invest your money in various funds. Each account type lets you choose between the traditional option using pre-tax dollars and a Roth account that invests in post-tax dollars.

Participants are also permitted to contribute funds to both accounts if they meet eligibility requirements:

• Your income may limit your eligibility for tax deductions.
• You must have earned income during the tax year to contribute to an IRA.
• You can also fund an IRA for a spouse.
• You’re only permitted to contribute to a 401(k) account if your employer provides one.
• Employers must allow employees to participate if they are over the age of 21 and have worked over 1,000 hours within a year of service.

Can I have both?

Yes, you can open an IRA on your own while also enrolled in an employer-sponsored 401(k) plan. Because a 401(k) plan has higher contribution limits, as well as the option for employee matching, you may save more money for retirement by having both accounts. Plus, you can roll over your 401(k) into your IRA if needed.

Do you have more questions about IRAs or our 401(k) options? Reach out to the retirement sales consultants at ePlan Services today for more information.

This content is for educational purposes only, is not intended to provide specific legal or financial advice, and should not be used as a substitute for the legal advice of a qualified attorney or financial professional. The information may not reflect the most current legal developments, may be changed without notice and is not guaranteed to be complete, correct, or up-to-date.