Major Differences between Retirement Plans – 401k vs. IRA vs. Roth IRA

Retirement Jar Filled With Money

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| Featured Author: Austin Hagaman |

Austin Hagaman's pencil headshot | PWMGetting Serious About Retirement 

No matter when you are planning to retire, one simple fact remains constant; you cannot rely on Social Security to support you during your retirement years. For most, Social Security benefits will not provide sufficient retirement income and for those under 30, like me, Social Security may not exist in its current form when we are ready to retire.

Getting serious about retirement begins with two questions, “What kinds of retirement accounts can I participate in?” followed by, “What are the differences between retirement accounts?”—The answer to the first question is rather simple. There are two main types of retirement accounts: a 401k and an IRA. Now let’s explore the differences between the two.

What is a 401k?

A 401k is an employer maintained, tax-advantaged contribution plan (If you are a government employee, you would have a 403b.) A 401k can be funded from one or more of the following sources: employee elective salary deferrals, matching employer contributions, and/or employer profit sharing plan contributions. When you set up a 401k, a certain percentage of your check is deposited directly into your 401k account (subject to limitations). The contributions to your 401k are tax free until you withdraw them after reaching a minimum required age of 59 ½ –withdrawals before age 59 ½ are subject to IRS penalties. Depending on your employer’s plan, you may or may not have investment discretion over your account. In either scenario your contributions will typically be invested in a mutual fund or group of similar investments.

Example of an Employer Matching an Employee's 401k ContributionAs an additional benefit to employees, some companies will match your 401k contributions. For example, they may give you a 50% “match” if you contribute up to 5% of your income or a 100% “match” if you contribute up to 10% of your income into a corporate retirement account. Meaning, if you earn $50,000 a year and you contribute 10% of your earnings or $5,000 into a plan your employer will also contribute $5,000. Of course, not all employers match your contributions and the amounts matched will vary from company to company.

What is an IRA?

There are two main types of IRAs (Individual Retirement Accounts): the Traditional IRA and the Roth IRA.

Traditional IRA

A traditional IRA is very similar to a 401k. With a Traditional IRA, you can contribute up to $5,000 a year ($6,000 if age is 60 or older) as long as your salary is below a certain amount (see table below). The money is contributed tax free just like a 401k (subject to limitations). An important difference between a traditional IRA and 401k is that an IRA is not maintained by your employer (you need to set it up through a bank or brokerage firm) and an IRA does not qualify for an employer match.

Roth IRA

A Roth IRA has many rules that are similar to a traditional IRA. The main difference between a traditional IRA and Roth IRA is that Roth IRA contributions are made with after tax dollars but all distributions including capital gains, are tax-free when you withdraw them (post age 59 ½).

Charting the Differences: 401k vs. IRA vs. Roth IRA

I have included the below chart to further summarize the differences between 401k, IRA, and Roth IRA retirement accounts.

Chart Comparing Retirement Accounts: 401k, IRA & Roth IRA

*Subject to limitations and IRS guidelines. Due to various factors, including changing market conditions and/or applicable laws, the presented material(s) may no longer be reflective of current opinions or positions. You should not assume that the information contained in this chart serves as the receipt of, or as a substitute for, personalized investment advice from PWM. Please consult with your financial professional regarding such services.

Retirement Account Limitations & Government Restrictions

It is important to understand that there are many limitations and government restrictions that affect all retirement accounts. For example, not everyone qualifies for tax-advantaged retirement accounts. If you make over a certain amount you may not be able to use, or can only partially use, tax advantage retirement accounts. Speak with your employer to see if you can participate in a corporate retirement account. Your accountant or investment professional should be able to guide you on whether an IRA or Roth IRA represents a suitable alternative.

Learn More About This Topic:  Important Retirement Planning Questions (& Answers) – For Beginners

Due to various factors, including changing market conditions and/or applicable laws, the presented material(s) may no longer be reflective of current opinions or positions. The thoughts and opinions expressed in the presented material(s) relate only to the author and are not necessarily reflective of PWM’s views. Moreover, you should not assume that any discussion or information contained in the presented material(s) serves as the receipt of, or as a substitute for, personalized investment advice from PWM. Photo Credit: Tax Credits – flickr

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