The key difference between IRA and 401k is that IRA is planned by the employee, whereas, 401k is planned by the employer.
IRA and 401k are two retirement plans that come under the tax law of the United States. Although both are retirement plans, they have some differences between them. In this article, we refer to the traditional IRA by the term as IRA. Both IRA and 401k retirement plans are tax-saving plans as they fall under the lower income tax bracket. Moreover, both get favourable tax treatment.
CONTENTS
1. Overview and Key Difference
2. What is IRA
3. What is 401k
4. Side by Side Comparison – IRA vs 401k in Tabular Form
5. Summary
What is IRA?
IRA or the Individual Retirement Arrangement is planned by the employee. An employee can withdraw funds starting from the age of 59 1/2 year. Since this plan is set by the employee himself, he can start withdrawing funds before the age of 59 1/2 year, even if he continues to work in the same concern or firm. When we look at the contribution, 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.
Unlike the 401K plan, IRA plan does not allow you to borrow loans against the vested account balance. You will have to find out any other alternative to IRA loans.
What is 401k?
Unlike the IRA, 401k is planned by the employer. In 401k, if a person withdraws funds before the retirement age, then he is liable to pay 10% on tax. Since 401k is a very effective retirement plan that is capable of providing you with 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.
Moreover, the 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.
What is the Difference Between IRA and 401k?
The key difference between IRA and 401k is that IRA is planned by the employee, whereas, 401k is planned by the employer. Another difference between IRA and 401k is their contribution rate. In 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 a 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. Moreover, the 401k plan allows borrowing against the vested account balance. You can borrow a loan up to 50% of the vested account balance as long as the maximum amount of loan does not exceed $50,000, and the loan has to be of course repaid within a period of 5 years. IRA plan, on the contrary, does not allow you to borrow loans against the vested account balance.
Summary – IRA vs 401k
Both IRA and 401k retirement plans are tax-saving plans as they fall under the lower income tax bracket. The key difference between IRA and 401k is that IRA is planned by the employee, whereas, 401k is planned by the employer.
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