Whats the difference between an ira and a 401k

Individual Retirement Accounts (IRAs) and 401(k) plans are the two most common vehicles used to save for retirement. Both offer tax benefits and have flexible contribution options. Both can provide retirement savings benefits to employees as well as business owners. Many people choose to save in just one type of account, but you don’t have to pick one, you can save in both.

Ubiquity Retirement + Savings: 401(k) vs. IRA Plans Amber Fording with Ubiquity Retirement + Savings discusses the main differences between an IRA and a 401(k) plan.

The primary difference between an IRA and a 401(k) is that a 401(k) plan must be established by an employer. Each employee and the business owner decides whether to put a portion of their pay into the plan. The contributions for all employees and owners are held in a single plan trust, but each individual’s account balance is tracked separately. For 401(k) plans that have employees, the employer has the option of making contributions to the employees’ account.

An IRA, on the other hand, is an individual account, not tied to an employer. Individuals set up their IRAs with an IRA provider. They can choose to contribute a portion of their earned income periodically to the IRA. They can also fund the IRA with dollars rolled over from a former employer’s retirement plan, such as a 401(k) plan.

IRAs and 401(k) plans provide some of the same savings and tax benefits, but each has its own rules, and there are different rules for different types of IRAs and 401(k) plans.

Traditional IRA vs. 401(k)

Both a traditional IRA and a 401(k) plan provide a tax benefit each year an individual contributes to the plan. However, the contribution and withdrawal rules for these two savings arrangements are very different.

Traditional IRA

Pretax 401(k)

Maximum Contributions

$6,000 for 2022, plus $1,000 catch-up contribution if age 50 or older

$20,500 for 2022 for employee contributions $6,500 catch-up contribution if age 50 or older Employer contributions (matching, profit sharing) up to 25% of compensation Combined employee and employer contributions limited to 100% of employee’s compensation up to $61,000 for 2022.

Taxation of Contributions

Contributions are generally tax-deductible reducing taxable income during each contribution year.

Investment earnings are not taxed until withdrawn from the IRA.

Pretax employee contributions are made with before-tax dollars, reducing taxable income during each contribution year.

Investment earnings are not taxed until withdrawn from the 401(k).

Eligibility to Participate

Any individual with earned income who is under age 70½ may contribute.
Income limits apply to receive a tax deduction if IRA owner or spouse is participating in an employer’s retirement plan. Single IRA owners may not take a tax deduction if they earn more than $78,000 for 2022. Married IRA owners filing a joint tax return may not take a tax deduction if they and their spouse earn more than $129,000. If the IRA owner does not participate in a retirement plan, but the spouse does, a deduction is not allowed if together they earn more than $214,000.

The employer may set certain age or length-of-service requirements an employee must meet to be eligible to participate in the 401(k).

Withdrawal Rules

IRA owners may withdraw money at any time.

Employees generally must have reached a distribution event before they can access their savings. Common distribution events include no longer working for the employer sponsoring the plan, becoming disabled, reaching age 59½, and death. Employers may permit employees to take loans and hardship distributions while still employed.

Taxation of Withdrawals

IRA owners will need to pay income tax on the money they withdraw from the IRA in the year they take the withdrawal.
Taxable withdrawals are subject to a 10% early distribution tax if under age 59½ at the time of withdrawal (unless a penalty
exception applies).

Employees will need to pay income tax on the pretax employee contributions, employer contributions, and earnings withdrawn from the
401(k) in the year they take the withdrawal.
Taxable withdrawals are subject to a 10% early distribution tax if under age 59½ at time of withdrawal (unless a penalty exception applies).

Required Withdrawals

Annual withdrawals are required beginning when the IRA owner turns age 72.

Annual withdrawals generally must begin when the employee or business owner turns age 72.
If an employee age 72 or older is still working for the employer, the employee may be allowed to delay taking required payments until the year they retire. This delay is not available for business owners of 5% or more of the company.

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