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Thursday, 05 January 2017 17:56

401(k) vs. IRA: What are the Differences?

Planning for retirement is a fantastic idea, and the earlier you begin to do so, the better. But with all the different investment vehicles for you to choose from, it can be hard to narrow them down to find the perfect fit. These days, two of the most common defined contribution plans are IRAs and 401(k)s – both of which offer tax-advantaged ways to save for retirement.

The good news is, you don’t have to pick just one! Often times good retirement planning will involve multiple retirement accounts. But it doesn’t hurt to have a clear understanding of the key points that differentiate these to popular types of accounts.

Who Can Participate

Anyone can participate in an IRA as long as they are earning an income and are under the age of 70. Additionally, if you are working but have a non-working spouse, you can make an IRA contribution for that spouse so long as the contribution isn’t more than your income.

To participate in a 401(k), your employer must provide the plan. Your employer can also place limitations on who can participate in the 401(k) and when they are allowed to do so.

Contribution Limits

For IRAs and 401(k)s, the IRS sets the contribution limit a person can make. For 2016 and 2017, the IRA annual contribution limit is $5,500 and the 401(k) contribution limit is $18,000. Once the account owner is older than 50, catch up contributions come into play. The catch up contribution limit for an IRA is $6,500 per year while the catch up contribution for a 401(k) is $24,000. The 401(k) contributions are taken directly from the employee’s paycheck before taxes; and, later, the distributions are taxed as ordinary income. Contributions to a Traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal, while contributions to a Roth IRA are taxed, although the assets in a Roth IRA do grow tax-deferred and the qualified distributions are not taxed (limitations and restrictions may apply).

Distribution Rules

401(k)s have stricter rules when it comes to taking a distribution. In order for a participant to be eligible for one, there must be a qualifying event that triggers the distribution. Qualifying events include turning 59 ½, retirement, separating from service, etc. An IRA on the other hand does not require a qualifying event for a distribution. Participants of an IRA can take a distribution at any time, although they face possible penalties if they do so before age 59 ½.

With both IRA types - Traditional or Roth - distributions prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax; but for Roth IRAs, if distributions are taken within the first 5 years of the account's inception, the penalty is based on whichever is event is later. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Also, their tax treatment may change.

Required Minimum Distributions

Both IRAs and 401(k)s typically require required minimum distributions to start at age 70 ½, with the exception of Roth IRAs. Roth IRA owners and surviving spouses are not subject to minimum distributions.

For those who have more than one 401(k) account, annual RMDs must be taken separately from each account. Conversely, those with multiple IRAs can calculate the RMD for each separate IRA, then take the aggregate amount from any one or more IRAs.

As always, we highly recommend that you talk to an advisor when deciding how much to contribute or withdraw from a retirement account. Of course, your personal circumstances are unique to you and this information is not intended to be a substitute for individualized tax advice. For this reason, we also suggest consulting a qualified tax advisor who's able to address your specific tax situation. As comprehensive financial planners here at Walsh & Associates, retirement planning is a huge part of what we do. With over 30 years of experience, we are happy to help you with any retirement account questions you may have. Please do not hesitate to call or email.



1. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits

2. https://www.irs.gov/retirement-plans/individual-retirement-arrangements-iras-1

3. https://www.irs.gov/retirement-plans/401k-plans

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