What’s the Difference between an IRA and a 401(k)?

When you hear about retirement accounts, you’ll often catch the terms IRA (individual retirement account) and 401(k) – a qualified retirement plan offered through an employer. Even though there are other types of accounts available for retirement savings, we’re going to focus on IRAs and 401(k)s and the differences between them. Hopefully, this helps you choose the right type of savings for your situation.

Contribution Limits

Both the IRA and the 401(k) retirement savings accounts have separate annual contribution limits. They are as follows:

  •      IRA: Up to $5,500 or 100% of your compensation, whichever is lesser, or up to $6,500 if you are age 50 or older.
  •      401(k): Up to $18,000, or up to $24,000 for ages 50 and older, along with a 25% match of the contributions.

Income Limitations

When it comes to limitations on your income, the difference between an IRA and a 401(k) is big. With an IRA, if you make too much money, you may not be able to make contributions. The traditional and Roth IRA have different limitations for income.  In a 401(k) retirement savings account, however, there are no income limitations. Whether you have a traditional or Roth 401(k), you are allowed to put as much savings as you want in that account.

Borrowing

You may have heard you can borrow money from your retirement accounts. When it comes to IRAs and 401(k)s, the rules couldn’t be more different. In an IRA, you can take the money out for 60 days and, as long as you put it back within those 60 days, there is no penalty or taxes. The 401(k) does not offer this 60-day program; however, if the plan allows there are borrowing provisions that allow you to withdraw $50,000 or up to 50% of your balance. Note: upon separation from the employer any remaining loan balance may become taxable including penalty taxes if under the age of 59.5.

 

Taxes

Both the IRA and 401(k) are tax-advantaged retirement savings vehicles, but the ways in which they are taxed can vary. For example, contributions to a traditional IRA and a 401(k) account are made with pre-tax dollars, meaning the money is not taxed before going into the account. Contributions to Roth IRAs, on the other hand, are taxed before going into the account. It’s good to know the differences between an IRA and 401(k) in regards to taxes because it can affect your finances when you take distributions later on.

To determine which account is right for you, we recommend speaking with an attorney, CPA or your financial advisor. It’s important to understand all the pros and cons associated with each retirement savings account before moving forward.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Guidant Wealth Advisors and LPL Financial do not provide legal advice or services.

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