401(k) vs IRA: Basic Differences

Humans share 90% of their DNA with mice, cattle, dogs and elephants. Similarly, 401(k) accounts and IRAs (Individual Retirement Accounts) are about 90% similar. But as with humans versus cows, the 10% difference could be pretty significant.

The 401(k) Account:
– The amount that you are able to contribute each year is currently $20,500 ($27,000 if you are 50 or older.)
– You can take a loan from a 401(k).
– Withdrawals before the age of 59 ½ are usually allowed for “hardships”, a somewhat nebulous term defined by your employer’s 401(k) plan administrator. (There will still often be a 10% penalty, however.)
– The “Rule of 55” applies. This means that you can make penalty-free withdrawals from the 401(k) account of your last employer if you are at least 55 years old and leave that job.
– Your employer may match your 401(k) contributions.
– Money in a 401(k) account is usually fully protected if you file bankruptcy.
– If you continue to work after the age of 72 at the company where your 401(k) is held, you will not be required to take Required Minimum Distributions (RMD).
– For most people, the income limit for contributing to a 401(k) is not a factor.

The IRA Account:
– The amount that you are able to contribute each year is currently $6,000 ($7,000 if you are 50 or older).
– You cannot take a loan from an IRA.
– The “Rule of 55” does not apply.
– Similar to a 401(k), except for very specific hardships (such as large medical costs, disability), penalty-free withdrawals usually cannot happen until you are 59 ½ years old. However, there are limited exceptions to the 10% penalty for qualified education expenses, first time home purchases and birth or adoption of a child. (Income tax may still apply depending on the purpose.)
– Money in an IRA is protected in bankruptcy, but only up to about $1,362,800. (The number is inflation-adjusted annually.)
– Sometimes there are more low fee investment choices with an IRA than a 401(k).
– You can contribute to an IRA either regularly or intermittently, as you prefer.
– Your ability to contribute to a Roth IRA, or take a tax deduction for contributions to a traditional IRA, is limited by your income.

What about the Roth 401(k) versus Roth IRA? Much of the above applies, with an extra twist:
While there are no RMDs with Roth IRA accounts, the RMD rule does apply to the Roth 401(k).

For many, having a foot in both camps is the right choice, either to save more overall to fund retirement or to take advantage of specific provisions that are unique to a particular type of retirement account. As always though, the most important decision is to save enough for retirement, regardless of which vehicle you choose.

Financial Guide

Lisa W.

Accredited Financial Counselor®

Chartered Retirement Planning Counselor℠

I love being a Financial Guide because I enjoy making the seemingly complex simple. It's tremendous fun to help someone solve a financial planning puzzle.