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Retirement basics: Know the difference between 401k and IRA

What are the key differences between a 401k and IRA? Take a look at the difference between these two tax-advantaged options, and learn how to increase your retirement savings.



What is a 401(k) Retirement Plan?

It is an employer-sponsored retirement savings plan where eligible employees can contribute towards their retirement savings on either an after-tax or pretax basis. The employer offering a 410(k) may choose to make a matching contribution to the plan or add a profit-sharing feature.

What is an IRA?

An IRA is an Individual Retirement savings account that offers pre-tax or after-tax advantages. Every IRA must have a custodian and the choice of investments available to you will greatly depend upon the custodian you choose.

There are three types of custodians. The first will help you establish a new self-directed IRA but your investment options are limited to what they have to sell. The second will allow you to invest in anything allowed by the IRS BUT you have to run everything through them and of course, that incurs continuing fees. The third is a passive custodian, they don’t have products to sell AND let you invest in any alternative investment without going through them.

401k vs IRA: Key differences

While both 401(k) and IRA make great options for retirement savings, it is important to know the key differences between them to determine which best suits your unique situation:

Tax Year 2018 401(k) IRA
Eligibility Anyone who is employed in an organization where the employer or sole proprietor offers a 401(k) plan Anyone who is below the age of 70 ½ for Traditional IRA’s, not Roth, and has earned income can contribute to an individual retirement account.
Subjected Taxes Contributions are tax deductible unless it is a Roth contribution.

Traditional distributions will be treated as ordinary income. Roth distributions are not taxed if the rules are met

Contributions are tax deductible unless it is Roth IRA. Traditional distributions will be treated as ordinary income. Roth distributions are not taxed if the rules are met.
Flexibility You cannot contribute to your 401(k) plan after the completion of employment. Your 401(k) can be rolled over to an IRA and you can continue to invest.
Contribution Limits (Basic) $18,500 $5,500
Catch-up Contribution Limits (Age 50 and above) $6,000 $1,000
Profit Share Up to $26,000 No profit share

Making a sound choice

If your employer is offering a 401(k) plan, it is smart to make the most of your employer’s matching contributions. Plus, automatic deductions from your payroll make retirement savings easier, either Traditional or Roth. If your employer does not offer a 401(k), you can still ensure that your earnings grow tax-deferred and/or tax-free by utilizing investment options in an IRA.

One last thing on your retirement savings

Retire from work, not retirement savings. If you are eligible for both 401(k) and IRA, save as much as you can while keeping within contribution limits. If you are fortunate to have a 401 k plan, contribute and take advantage of any “match”. Consider maxing out an IRA and then go back to funding the 401 k as much as you can.

DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation for writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.

Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ. He has over three decades of experience working with investments and retirement planning, and over the last 10 years has turned his focus to self-directed accounts and alternative investments. Rick regularly posts helpful tips and articles on his blog at SD Retirement as well as, SAP, MoneyForLunch, Biggerpocket, SocialMediaToday, and NuWireInvestor. If you need help and guidance with traditional or alternative investments, get in touch with Rick.