401k vs IRA: What’s The Difference, And How To Choose?

401k vs IRA What's The Difference, And How To Choose

When it comes to the best retirement savings, there are many options that you can come across in the United States. The two most popular plans are the IRA (Individual Retirement Account) and the 401k plan. It is common to get confused between the two. To find out the difference between these two retirement options, 401k vs IRA, read on through to the end of the article.

In this article, you will learn some of the major details of the IRA (Individual Retirement Account) and the 401k retirement plan. In addition to that, we will discuss the major differences between these two retirement options. Finally, you will have a better opinion of which one to choose for yourself based on your current financial situation, age, and many more factors.


What Are Individual Retirement Accounts (IRAs) And 401k Accounts?

According to BankRate.com,

A 401(k) plan is an employer-sponsored retirement plan that allows a company’s workers to save for retirement on a tax-advantaged basis. In a 401(k), money can grow tax-deferred or tax-free until withdrawn at retirement.

Here, employees have the option to deduct a salary portion and invest in any high-returning asset.

On the other hand, the IRA is just an individual retirement account to which anyone with an earned income can contribute. Here, the money also grows tax-free and is taxed like an ordinary income after withdrawal at retirement.

401k Vs IRA: Difference Between IRA And 401k

According to Nerdwallet,

The main difference between 401(k)s and IRAs is that 401(k)s are offered through employers, whereas IRAs are opened by individuals through a broker or a bank. IRAs typically offer more investment options, but 401(k)s allow higher annual contributions.

Here are some of the major differences between IRA and 401k options:

1. Contribution Limit

As of 2023, the contribution limit of 401k is $22,500 ($30,000 for age 50 or higher). While with the IRA, the contribution limit is $6,500 ($7,500 for those aged 50 or higher).

2. Employer’s Matching Contribution

With 401k, you can get a match of 3% from the employer. However, with the IRA, you do not get an employer match.

3. Tax Treatment

With 401k, you can lower your taxable income for the year. However, your distributions in retirement will be taxed like ordinary income.

On the other hand, with the IRA, if your contributions are tax-deductible, your taxable income is reduced in the given year. However, your distributions in retirement will be taxed like ordinary income.

4. Account Eligibility

No matter what your income is, you are eligible to open a 401k account. With an IRA, if you and your spouse get coverage by a workplace retirement account, you will get phased-out deductions once your income gets higher.

5. Investment Options

With 401k, you do not have any control over your investment costs and plans. Furthermore, investment selections are limited as well. On the other hand, with IRAs, you get a large investment selection.

6. Required Minimum Distributions

With 401k, you can avail required minimum distributions at the age of 73 (as of 2023 data). This is the same with IRA. In both the cases, the number was 72 for the year 2022.

IRA Vs 401k: Which One To Choose?

To put it simply, it is for you to choose which of IRA and 401k is the right option for you. You must note here that both IRA and 401k are pretax options, as compared to Roth IRA and Roth 401k. To find out about Roth IRA Vs 401k Roth, click on the given link.

Pretax means that you are contributing your amount from your gross salary, i.e., that money has tax liabilities. Hence, after your retirement, when you withdraw the money, it is liable for tax deductions. In a Roth account (IRA or 401k), since the taxes are paid before contributions, it is not liable for deductions at the time of withdrawal.

Now If you choose the pretax option, you have two further options – 401k an IRA. With the 401k option, you can contribute more money each year, although it is pretax money. This is not possible with IRA contributions. However, with the IRA account, you have many more investment options, which is not possible with 401k accounts.

While you have greater control and flexibility over your accounts with the IRA, you will not get the same with the 401k. This is because your employer sponsors your 401k account. On the other hand, you can establish an IRA account without the involvement of your owner.

However, just because both of them are pretax options, it does not mean that they have the same tax benefits. Tax benefits are different for IRA and 401k accounts. While IRAs offer you a tax deduction option, with 401ks, you have to deposit your pre-tax income, which means that you can reduce the taxable income of your year. However, it will later be liable for tax deductions. However, in both cases, the distributions after retirement are liable for taxation.

Do you know that there is a slight chance of losing money through the IRA option?

According to Investopedia,

IRA money held by a brokerage or investment firm is usually invested in securities such as mutual funds or stocks, which fluctuate in value. Note that an IRA is no more or less likely to decline in value than any other investment account. The owner of an IRA faces the same market risks as the account holder of a 401(k).

Final Thoughts

401k vs IRA: Which one is better? – You can learn from this article that both the IRA and the 401k are great options and come with their own advantages and disadvantages. You have to understand here that although 401k is the better option when it comes to contribution limits, your choices are fewer since it is an employer-sponsored plan.

However, if you want to create a comprehensive retirement and savings portfolio, you can choose the two accounts together. Do you have any more essential information to add regarding 401k vs IRA? Share your views with us in the comments section below.

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