IRA vs. 401(k) – What are the Differences?
Find out the differences and your options
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Find out the differences and your options
Individual Retirement Accounts (IRAs) and 401(k) plans are the two most common vehicles used to save for retirement. Both offer tax benefits and have flexible contribution options. Both can provide retirement savings benefits to employees as well as business owners. Many people choose to save in just one type of account, but you don’t have to pick one, you can save in both.
The primary difference between an IRA and a 401(k) is that a 401(k) plan must be established by an employer. Each employee and the business owner decides whether to put a portion of their pay into the plan. The contributions for all employees and owners are held in a single plan trust, but each individual’s account balance is tracked separately. For 401(k) plans that have employees, the employer has the option of making contributions to the employees’ account.
An IRA, on the other hand, is an individual account, not tied to an employer. Individuals set up their IRAs with an IRA provider. They can choose to contribute a portion of their earned income periodically to the IRA. They can also fund the IRA with dollars rolled over from a former employer’s retirement plan, such as a 401(k) plan.
IRAs and 401(k) plans provide some of the same savings and tax benefits, but each has its own rules, and there are different rules for different types of IRAs and 401(k) plans.
Both a traditional IRA and a 401(k) plan provide a tax benefit each year an individual contributes to the plan. However, the contribution and withdrawal rules for these two savings arrangements are very different.
Traditional IRA
Pretax 401(k)
Maximum Contributions
$6,500 for 2022, plus $1,000 catch-up contribution if age 50 or older
$22,500 for 2023 for employee contributions $7,500 catch-up contribution if age 50 or older Employer contributions (matching, profit sharing) up to 25% of compensation Combined employee and employer contributions limited to 100% of employee’s compensation up to $66,000 for 2022.
Taxation of Contributions
Contributions are generally tax-deductible reducing taxable income during each contribution year.
Investment earnings are not taxed until withdrawn from the IRA.
Pretax employee contributions are made with before-tax dollars, reducing taxable income during each contribution year.
Investment earnings are not taxed until withdrawn from the 401(k).
Eligibility to Participate
Any individual with earned income who is under age 70½ may contribute.
Income limits apply to receive a tax deduction if IRA owner or spouse is participating in an employer’s retirement plan. Single IRA owners may not take a tax deduction if they earn more than $83,000 for 2023. Married IRA owners filing a joint tax return may not take a tax deduction if they and their spouse earn more than $136,000. If the IRA owner does not participate in a retirement plan, but the spouse does, a deduction is not allowed if together they earn more than $228,000.
The employer may set certain age or length-of-service requirements an employee must meet to be eligible to participate in the 401(k).
Withdrawal Rules
IRA owners may withdraw money at any time.
Employees generally must have reached a distribution event before they can access their savings. Common distribution events include no longer working for the employer sponsoring the plan, becoming disabled, reaching age 59½, and death. Employers may permit employees to take loans and hardship distributions while still employed.
Taxation of Withdrawals
IRA owners will need to pay income tax on the money they withdraw from the IRA in the year they take the withdrawal.
Taxable withdrawals are subject to a 10% early distribution tax if under age 59½ at the time of withdrawal (unless a penalty
exception applies).
Employees will need to pay income tax on the pretax employee contributions, employer contributions, and earnings withdrawn from the
401(k) in the year they take the withdrawal.
Taxable withdrawals are subject to a 10% early distribution tax if under age 59½ at time of withdrawal (unless a penalty exception applies).
Required Withdrawals
Annual withdrawals are required beginning when the IRA owner turns age 72.
Annual withdrawals generally must begin when the employee or business owner turns age 72.
If an employee age 72 or older is still working for the employer, the employee may be allowed to delay taking required payments until the year they retire. This delay is not available for business owners of 5% or more of the company.
A 401(k) plan and an IRA can be designed to permit contributions with after-tax dollars – referred to as Roth 401(k) contributions and Roth IRAs. While these options do not provide a tax benefit in the year the contribution is made, they do eliminate taxes when you withdraw your money upon retirement. Each type has distinct rules.
Roth IRA
Roth 401(k)
Maximum Elective Contribution
$6,500 for 2023, plus $1,000 catch-up contribution if age 50 or older
$22,500 for 2023 for employee contributions $7,500 catch-up contribution if age 50 or older Employer contributions (matching, profit sharing) can be up to 25% of compensation Combined employee and employer contributions limited to 100% of employee’s compensation up to $66,000 for 2023.
Taxations of Contributions
Roth IRA contributions are made with after-tax dollars, so IRA owners do not have to pay taxes on contributions when withdrawn from the Roth IRA.
Tax on investment earnings is deferred while held in the Roth IRA and potentially tax-free upon distribution.
Designated Roth contributions are made with after-tax dollars, so employees do not have to pay taxes on contributions when withdrawn from the Roth 401(k).
Tax on investment earnings is deferred while held in the Roth 401(k) and potentially tax-free upon distribution.
Eligibility to Participate
Income limits apply to contribute to a Roth IRA. (Rollovers to Roth IRAs are not subject to income eligibility.)
Single IRA owners may not contribute to a Roth IRA if they earn more than $153,000
for 2023. Married IRA owners filing a joint tax return may not contribute to a Roth IRA if they and their spouse earn more than $228,000.
The employer may select certain age or length-
of-service requirements an employee must meet to be eligible to participate in the 401(k).
Withdrawal Rules
IRA owners may withdraw money at any time.
Employees generally must have reached a distribution event before they can access their savings. Common distribution events include no longer working for the employer sponsoring the plan, becoming disabled, reaching age 59½, and death. Employers may permit employees to take loans and hardship distributions while still employed.
Taxation of Withdrawals
Roth IRA contributions are not taxed upon withdrawal. Withdrawals of earnings are
not taxed if the withdrawal is qualified.
This means that the Roth IRA owner has had a Roth IRA for at least 5 years and is:
Roth 401(k) contributions are not taxed upon withdrawal. Withdrawals of earnings are not taxed if the withdrawal is qualified. This means that the employee has had the Roth account for at least 5 years and is:
Required Withdrawals
Withdrawals are not required to begin at age 70½ for Roth IRAs. IRA owners are never required to take a withdrawal from a Roth IRA. (Roth IRA beneficiaries must begin taking payments after the death of the Roth IRA owner.)
Withdrawals must generally begin when the employee turns age 70½.
If an employee age 70½ or older is still working for the employer, the employee may be allowed to delay taking required payments until the year they retire. This delay is not available for business owners of 5% or more of the company.
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We should all be saving as much as we can for retirement. Financial experts often suggest saving 10% or more of your income throughout your working years so you have enough to live comfortably in retirement.
But there are some tax issues you will want to understand if you are eligible to contribute to both a 401(k) and an IRA. For example, if you participate in a 401(k) and you are married and filing a joint tax return, you cannot take a tax deduction for a traditional IRA contribution if you and your spouse earn more than $129,000. You can still make an after-tax contribution to a traditional IRA, but you may want to contribute to a Roth IRA instead.
You may want to consult a financial or tax advisor to determine the best savings options to help you reach your tax and retirement income goals. Some common suggestions, depending on an individual’s financial situation, include funding a 401(k) in the amount needed to receive the full employer matching contribution before saving in an IRA, and splitting retirement savings contributions between pretax and Roth contributions to take advantage of both types of tax benefits.
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Schedule a Free Consultation
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© 2024 Ubiquity Retirement + Savings
44 Montgomery Street, Suite 300
San Francisco, CA 94104
