401(k) vs. IRA

401(k) vs. IRA - What's the Difference?
The fourth in a series of quick hitter Friday personal finance posts.

If you’re starting to think about saving for retirement, you might be wondering what the difference is between a 401(k) and an IRA. When I started my retirement planning, I was clueless. As it turns out, the basic differences are pretty simple. Here’s what you need to know!

What is a 401(k)?

A 401(k) is an employer sponsored retirement account. If you participate, a percentage of your paycheck will be deducted each month (before tax is taken out) and contributed to an investment account. Your investment choices will depend on the 401(k) plan your employer has chosen. 

One major differentiator of the 401(k) is the  “Company Match”. Many employers match what you contribute, up to a certain percentage (FREE MONEY!). For example, if you make $5,000 per month before taxes and elect to contribute 5% ($250) of your income, your employer will match your contribution and deposit an additional $250 (assuming they have a 5% match). Getting “the match” should be a top priority for retirement savings. 

  • Income Limits: None
  • Contribution Limits: $18,500* (new for 2018) 
  • Tax Advantaged: Yes
  • Early Withdrawal Penalty: 10% (before 59 1/2)
 
 *Up to $24,500 if over 50
 

What is a Traditional/Roth IRA (Individual Retirement Account)?

An IRA is a tax advantaged account offered by many different financial institutions to help you save for retirement. There are a variety of different types of IRAs (Roth, Traditional, SIMPLE, SEP). However, this post only covers basic Roth and Traditional However, more info on SIMPLE vs SEP is available here

Traditional or Roth IRAs are good options if you max out your 401(k) and want to save more, if your company doesn’t offer a retirement plan or if you are a stay at home mom/dad.  You will need to set an IRA up on your own by working with a brokerage firm or other financial institution (we use Vanguard). 

  • Income Limits: See below
  • Contribution Limits: $5,500 ($6,500 if over 50)
  • Tax Advantaged: Yes
  • Early Withdrawal Penalty: 10% (before 59 1/2)
 

There are income limits for Roth IRA contributions. If you are married filing jointly, you cannot contribute to a Roth IRA if your income exceeds $199,000 per year. If you are single, the limit is $135,000.

Here’s where it gets a little complicated… If you are married filing jointly and make between  $189,000-$199,000 (referred to as the phase-out range), you can make a partial contribution (see resources for calculator). If you are single, the phase-out range is between $120,000-$135,000.

So, what are the differences between a ROTH and Traditional IRA?

The biggest difference is contributions to a ROTH are taxed on the way in and grow tax free while contributions to a Traditional IRA are not taxed until you start making withdrawals. When you start making withdrawals from your Traditional IRA, you pay taxes on the original contributions and any earnings. Click here for a comparison chart!

Can I contribute to a 401(k) and an IRA in the same year?

YES!

Resources:

  • Fidelity has an easy IRA Contribution Limit Calculator you can use here
  • Roth IRA vs. Traditional IRA Comparison Chart here
 
If you’re starting to think about saving for retirement, or have already started and have questions about 401(k) vs IRA, leave a note in the comments or Email Me!
 
Have a great weekend!

TWH

401(k) vs. IRA – What’s the Difference?
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3 thoughts on “401(k) vs. IRA – What’s the Difference?

  • January 5, 2018 at 9:04 pm
    Permalink

    Great article Jason! Do you know if we can exclude BAH/BAS from our MGI?

    Reply
    • January 5, 2018 at 9:31 pm
      Permalink

      Thanks Rae! Good question – For military members, BAH and BAS are tax exempt allowances, so they are not included in your AGI or MAGI.

      Reply
      • January 5, 2018 at 9:33 pm
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        MAGI…that’s what I was thinking of. Awesome thanks!

        Reply

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