IRA vs. 401(k) - What are the Differences?

Individual Retirement Accounts (IRAs) and 401(k) plans are the two most common types of accounts used to save for retirement. Both offer a plethora of tax benefits and other advantages that motivate employees and employers to save more, consistently. There has been confusion though around if employees can only pick one or the other, and the best account option to choose.

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The good news is you can take advantage and save in both! Knowing this, it’s important to understand the differences, rules, and benefits beforehand so you can make them work harder for you. Below, you can find everything you need to know.

What are the Definitions of an IRA vs. a 401(k)?

While both plans provide income in retirement, there are different rules for each around how they’re established and by who. The main difference between an IRA and a 401(k) is that a 401(k) plan must be established by an employer, while an IRA is an individual retirement account. Each employee and the business owner decide 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 everyone’s account balance is tracked separately. For 401(k) plans that have employees, employers have the option of making contributions to their employees’ account.

An IRA is an individual account and isn’t tied to an employer. Individuals set up their IRAs with an IRA provider and 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.

What are the Differences Between a Traditional IRA vs. 401(k)

Both a traditional IRA and a 401(k) plan provide tax benefits to participating individuals. But the contribution and withdrawal rules for these two are very different.

Contribution Limits:

IRA Contributions:

• $6,500 for 2024, plus $1,000 catch-up contribution if age 50 or older.

401(k) Contributions:

• $23,000 for 2024 for employee contributions, plus $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 $68,000 for 2024.

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 who has earned an income and is under 70½ years old may contribute.
• Income limits apply to receive a tax deduction if the 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 $84,000 for 2024.
  • Married IRA owners filing a joint tax return may not take a tax deduction if they and their spouse earn more than $138,000.
  • 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 $230,000.
  • Individual Retirement Accounts (IRAs) and 401(k) plans are the two most common types of accounts used to save for retirement. Both offer a plethora of tax benefits and other advantages that motivate employees and employers to save more, consistently. There has been confusion though around if employees can only pick one or the other, and the best account option to choose.
• 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 Withdrawals:

• IRA owners may withdraw money at any time.

401(k) Withdrawals:

• 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 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 59½ years old at the time of withdrawal (unless a penalty exception applies).

401(k) Withdrawals:

• 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 59½ years old at time of withdrawal (unless a penalty exception applies).

Required Withdrawals:

IRA:

• Annual withdrawals are required beginning when the IRA owner turns 73.

401(k):

• Annual withdrawals generally must begin when the employee or business owner turns 73 years old.
• If an employee is 73 or older, and 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.

Roth IRA vs. 401(k)

A 401(k) plan and an IRA can be designed to allow contributions to be made with after-tax dollars – also known 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

Maximum Elective Contribution

• $6,500 for 2024, plus a $1,000 catch-up contribution if a person is 50 or older.

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.

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 2024.
• 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.

Withdrawal Rules

• IRA owners may withdraw money at any time.
• 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:
  • Disabled
  • Deceased
  • Age 59½ or older
  • Making a first-time home purchase

Required Withdrawals

• Withdrawals are not required to begin at age 73 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.)

Roth 401(k)

Maximum Elective Contribution

• $23,000 for 2024 for employee contributions, plus $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 $68,000 for 2024.

Taxation of Contributions

• 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

• 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:

• 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.
• 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:
  • Disabled
  • Deceased
  • Age 59½ or older
  • (The first-time homebuyer event does not apply to Roth 401(k)s.)

Required Withdrawals:

• Withdrawals generally start when an employee turns 73 years old.
• If an employee, who is 73 or older, is still working for the same 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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Choosing Between the Two

Saving more towards retirement is the goal, and both account types can help you build the future you want. But you may want to consult a financial or tax advisor before jumping in to determine your best savings options, including 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.

Ubiquity can help you choose the best fitted plan for your needs, and further discuss how an IRA and 401(k) would boost your business. We boast transparent, low cost 401(k)s for both self-employed individuals and those who have employees and need something more robust. Even more, we offer major add-ons like a 3(16) fiduciary and Roth feature that will help you and your workforce maximize each dollar contributed.

“I am a new plan sponsor for my employer with Ubiquity. The friendliness of customer support was outstanding. ”

- Alan Drage, Great Basin Scientific