Broker Check

How Is An IRA Different From A 401(k)?

August 08, 2022

How Is An IRA Different From A 401(k)?

An IRA and a 401(k) are two common types of retirement accounts that offer users tax incentives when they invest. While there is some confluence to be had between the two types of investment accounts, they do possess traits that set them apart. Throughout this blog series, our team of investment advisors with Bridge Benefits Group will not only educate you on our services, but we also make it a personal mission of ours to teach you the basics of finances for both your business and personal ventures. For today’s topic, let’s address how an IRA is different from a 401(k).

What Are Traditional 401(k)s?

A 401(k) is a tax-deferred retirement savings account that employers will offer to their employees. Employees contribute to these accounts from salary deferrals, which means that a percentage of their salary is set aside for these investment accounts, every paycheck. The money is deposited in various investments, usually through a lineup of mutual funds, per the sponsor’s choice. The fund choices are designed to meet a specific risk tolerance so that employees can only take on as aggressive or conservative a risk, as they are comfortable in taking. Investment income accrues and compounds tax-free.

In addition to a traditional 401(k), several employers are also offering Roth 401(k)s as a viable alternative. Unlike the aforementioned, Roths are funded with after-tax money and are not tax-deductible.

Here are the other main characteristics that help depict and differentiate a 401(k) from an IRA:

Employee Contributions

Contributions made to a 401(k) are made with pretax dollars. This means that the total of the contributions would reduce your taxable income for that year, by the contribution amount. The contribution amounts change every year, but for 2022, participants are allowed to contribute $20,500 per year, to either a traditional or Roth 401(k). There is also an additional $6,500 permitted for catch-up contributions, allowed for those aged 50 and older.

Matching Contributions From Employer

Employers will usually match a percentage of their employees’ contributions up to a certain cap or percentage. The match might be based on how much that employee or employees contributes on a yearly basis. Here is a scenario that can aid with understanding. Suppose an employer wants to match 50% of an employee’s contribution (up to 6% of their salary). If an employee contributes 6% of their salary, then the employer will contribute with a 3% match. If the employee does not contribute the full 6%, they may not qualify for a match and receive either nothing or a minute portion from the employer. To receive an employer match, one needs to put forth a minimum amount or percentage of their salary. Our investment advisors will always recommend that you review your plan documents, so that all of these details are sorted out beforehand. The IRS has established limits on total contributions for both employers and employees. For 2022, annual contributions to an employee’s account can’t exceed $61,000 or $67,500, which surely includes catch-up contributions.

Distributions From 401(k)s

Withdrawals are taxed at the person’s income tax rate, and no penalties are incurred, for as long as the distributions are made at age 59.5 or older. An employee could be granted the opportunity to take out loans or hardship withdrawals from a 401(k). Loan repayments are typically deducted from the employee’s paycheck.

The Plan For Diversified Investment Options

For anyone on the fence about the limitations of many 401(k)s, expect imminent change that will make them more enticing. According to the Plan Sponsor Council of America’s survey, the number of investment options for 401(k) plans is on the rise. These days, the average plan offers 21 fund choices, as of 2020.

Individual Retirement Accounts (IRAs)

While we are not disputing the benefits of having and maintaining a 401(k), they are not the only retirement plan at your disposal. An individual retirement account or colloquially known as just IRA, is similar in structure, but one of the key differentiators is that it’s not tied to your place of employment. IRA’s can be opened up by a person, whether they are associated with an employer or not. They are suitable choices for independent contractors or for anyone that wants to diversify their retirement portfolio.

Additional Takeaways Of An IRA

  • Eligibility: In order to be eligible for this plan, you need to have earned income for that tax year.
  • Plan limits: The IRA contribution limit for 2021 and 2022 is $6000 if you are younger than 50. Anyone 50 and older, you are allowed an additional $1000 catch-up contributions for every tax year. The limits apply to both traditional and Roth IRAs.
  • Flexibility: Another important consideration when opening/selecting your investment accounts like these are the flexibility. Users can open an IRA at any brokerage of their choosing. You have the freedom to invest in any stocks, bonds, mutual funds, and exchange-traded funds (ETFs) that your brokerage company offers.

What Is A Roth IRA?

Roth IRAs are a type of individual retirement account that is similar to traditional IRAs in many ways, but with some obvious differences. The main difference here are the tax breaks. With a conventional IRA, the money you put in is not taxed. On the other hand, a Roth, the money you extract when the time comes, is not taxed. Roths are also not as stringent. In that, they do not have requirements on when they should be taken out. This is good news for anyone that has a good fortune of wealth to pass along to their beneficiaries.

IRA Vs 401(k): What’s Right For You? Our Investment Advisors Can Lend A Professional Hand

Our investment advisors will never force or expect you to pigeonhole yourself. After all, this is your financial freedom at stake. You are allowed to invest in both types of retirement accounts, assuming that you meet all the requirements. Both investment plans are strong tools with different strengths. Bridge Benefits Group is bound to always act in your best interest. If you would like to learn more specific investments, their criteria, and eligibility, contact us today!

“Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax. “

“A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.”

This information was developed as a general guide to educate plan sponsors, but is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does the advisor assure that, by using the information provided, the plan sponsor will be in compliance with ERISA regulations.