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A Guide to IRA vs. 401k

When starting to save up for retirement, individuals have a variety of retirement plans to choose from. Two of the most common options for retirement are the 401k and the individual retirement arrangement (IRA). The main difference between the IRA and the 401k arise from the source. A 401k is a type of retirement plan that is offered by a company or the employer. On the other hand, an IRA is set up by the individual, with aid from a bank or a mutual fund. 

The IRA

There are several types of IRA that fall within the blanket term of IRA. The following are some of the different types of IRAs that employees may choose to engage in:

Traditional IRA:
The traditional IRA is a popular option for many individuals that are looking for a retirement plan. The main advantages of traditional IRAs are that the contributions are tax-deductible, and individuals can receive immediate tax benefits. Yearly contributions are limited to about $6,000, depending on the age of the individual and whether the amount is adjusted to inflation.

Roth IRA:
Roth IRAs are not tax-deductable; however, these retirement plans can offer different benefits. First of all, withdrawals on Roth IRAs are less restricted, and can be taken out without a tax. Married couples also prefer Roth IRAs because it allows one to become the beneficiary of their deceased spouses’ IRA.

SEP IRA:
The main advantage of a Simplified Employee Pension IRA (SEP IRA) is that it allows businesses to provide retirement benefits for their staff members. Employee eligibility is relatively lax, as the only restrictions are that the employee is at least 21 years of age and have worked at the company for a minimum amount of time. SEP IRAs are also an attractive option for self-employed individuals.

SIMPLE IRA:
A SIMPLE IRA is similar to a SEP IRA in that it can allows employers to provide retirement benefits to employees. However, SIMPLE IRAs are mainly used by larger companies with upwards to 100 employees, and is relatively easy to set up and maintain. One distinguishing factor of SIMPLE IRAs is that employers must meet a minimum contribution requirement in order to engage in the plan.

The 401K

Traditional 401k:
A traditional 401k plan allows employees to put a portion of their income into a retirement plan. One distinguishing factor of 401ks is that contributions made into an account are comprised of income calculated before taxes. In addition, employers are able to match contributions made by their employees up to a certain amount. Withdrawals are subject to penalties and fees, and individuals considering a withdrawal should only do so in times of emergencies.

Roth 401k:
A Roth 401k plan combines features from a Roth IRA and a traditional 401k plan. Some of the qualities of Roth 401k plans include contributions made with after-tax dollars, and withdrawals are not taxed if the individual meets certain requirements. To examine the difference between Roth 401k, Roth IRA and traditional IRA plans, the US Department of Labor provides statistics and additional resources.