Broker Check
401K Vs. IRA: What's The Difference

401K Vs. IRA: What's The Difference

| November 24, 2021

Saving for retirement is extremely important. You’re preparing for your golden years of enjoying life without working. However, during your retirement you are not receiving a paycheck, instead you are only living off of your savings. To start saving for retirement, you need to decide the best savings vehicle for you, a 401(k) or an IRA. Continue reading to learn the difference between a 401(k) and an IRA.  

A 401(k) is a tax-deferred employer sponsored retirement savings account. Employees are able to contribute money into their 401(k) account from salary deferrals. These deferrals are a percentage of the employee’s salary that is withheld and funded into the 401(k). The money inside of a 401(k) is put into multiple investments, normally several mutual funds. The investment choices are made to meet a risk tolerance so the employee can take as much of an aggressive or conservative risk that they are comfortable with. The account’s growth compounds tax free. Employers typically provide a matching contribution based on a percentage of how much the employee puts into the 401(k) themselves. Qualified withdrawals are taxed at the person’s income tax rate at the time of withdrawal in most instances.   

Since 401(k) contributions are made with pre-tax money, your taxable income is lowered unless you are making Roth 401(k) contributions. If that is the case, you are using after-tax dollars to fund your 401(k), which means you do not receive a tax deduction.  For 2021, the contribution limit for both traditional and Roth 401(k)s is $19,500 with a $6,500 catch up contribution if you are age 50 or older.  

IRA stands for Individual Retirement Account. There are several different types, including Roth, Traditional, SEP, and SIMPLE. An IRA is similar to a traditional savings account. These accounts are held by brokerage and investment firms that offer many more investment options than 401(k)s, such as stocks, bonds, and real estate.  

For Traditional IRAs, contributions are tax deductible, similar to 401(k)s. Earnings grow tax free but are taxed when withdrawn. Roth IRA contributions are made with after-tax dollars, meaning you can’t receive a tax deduction from contributions. However, this allows you to take tax free withdrawals in retirement. The contribution limits for traditional and Roth IRAs in 2021 is $6,000, with a $1,000 catch up contribution if you are 50 years old or older.  

SEP and SIMPLE IRAs are sometimes offered as a retirement savings option by employers. They are similar to 401(k)s but are easier to set up on the administrative side. They have different contribution qualifications and contributions than Traditional IRA’s and Roth IRA’s. For SEP IRAs, only the employer can contribute. SEP IRAs have a limit of $58,000 for 2021, or $64,500 if the employee is over the age of 50. With SIMPLE IRAs, an employer can match up to 3% of an employee’s annual contribution or have a nonelective 2% contribution of the employee’s salary, which does not require the employee to contribute themselves. The limit for employee’s is $14,000 for 2021 with a catch-up contribution of $3,000.   

It is up to you to figure out which retirement account, or both, is best for you and your financial situation. If you’re not sure which is best for you, Plan A Wealth Management is here to help. Our trusted advisors are here to help you navigate the retirement savings process. Give us a call today to get started; your retirement portfolio will thank you.