Difference Between IRA and 401k

IRA vs 401k

At the outset IRA and 401k are two retirement plans that come under the tax law of the United States.  Although both are retirement plans they do have some differences among them.  Here what we refer as IRA is the traditional IRA.

One of the main differences between the traditional IRA and 401k  is that IRA or the Individual Retirement Arrangement is planned by the employee, whereas, 401k is planned by the employer.   An employee can withdraw funds starting from the age of 59 1/2 year. In 401k, if he withdraws funds before that age, then he is liable to pay 10% on tax.  The IRA plan differs in this aspect.  Since this plan is set by the employee himself, he can start withdrawing the funds before the age of 59 1/2 year, even if he continues to work in the same concern or firm.

Since 401k is a very effective retirement plan that is capable of providing you the best shield in terms of financial security after retirement, the government and the employer would not encourage you to go for an interim withdrawal.  That is why heavy tax penalties are inflicted on the person that wishes to go for early withdrawal in the 401k plan.  You can still avoid the situation of paying harsh tax penalties in the event of early withdrawals from your 401k account provided you stick to certain strict withdrawal rules as far as a 401k account is concerned.  In the case of an IRA plan you would have to pay taxes even in the event of hardship withdrawals such as withdrawals to pay off your or your dependent’s medical bills, pay the college fees for your children or pay off the mortgage loan of your house.

It is interesting to note that both IRA and 401k retirement plans are tax-saving plans in the sense that they fall under the lower income tax bracket.  Both get favorable tax treatment.  401k plan allows borrowing of loan against the vested account balance.  You can borrow a loan up to 50% of the vested account balance.  The maximum amount of loan should not exceed $50,000.  The loan has to be of course repaid within a period of 5 years.  The IRA plan on the contrary does not allow you to borrow loans against the vested account balance.  You will have to find out any other alternative to IRA loans.

Both IRA and 401k have some differences as far as contribution limits are concerned.  In the case of IRA if the person is 49 years of age or below, he can contribute up to $5k per year in the plan.  If he is 50 years of age or above he can contribute up to $6k per year.  In the case of 401k plan, a person of age below 50 can contribute up to $16.5 per year to the vested account balance.  A person of 50 years of age or above can of course contribute up to $22k per year to the vested account balance.