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IRA vs. 401(k): What's the difference?
January 20, 2023
The three most common types of retirement investment accounts are a 401(k), traditional IRA and Roth IRA.
If you’re eligible, it’s possible you could contribute to a 401(k) and an IRA, so it may be helpful to know how they compare from a contribution, withdrawal and tax perspective. Here’s a look at their similarities and differences.
IRA and 401(k) definitions
A 401(k) is a type of workplace retirement plan. Depending on the industry you work in, your workplace retirement plan may be called a 403(b) or 457.
An IRA is an individual retirement account that you open with a financial institution, either a bank or a brokerage firm. Types of IRAs available include traditional IRAs, Roth IRAs and even options for self-employed individuals and small business owners.
IRA vs. 401(k) contributions and investment selections
There’s a difference in how you fund 401(k)s and traditional/Roth IRAs, as well as the investment options available to you.
|
|
401(k) |
Traditional IRA |
Roth IRA |
|---|---|---|---|
|
Eligibility |
Most employers have certain qualifications you must meet to participate in their 401(k) savings plan, such as being at least 21 and employed with the organization for at least one year. |
Anyone with earned income. |
You must meet certain contribution criteria and tax filing requirements. |
|
Contribution details |
401(k) contributions are directly withdrawn from your paycheck with pre-tax dollars. |
Traditional IRAs can be funded with after-tax dollars or as tax-deductible contributions. |
Roth IRAs are funded with after-tax dollars. |
|
Annual contribution limit |
The annual limit for 2023 is $22,500. If you’re age 50 or older you can contribute an additional $7,500. |
The annual limit for the 2023 tax year is $6,500. If you’re age 50 or older you can contribute an additional $1,000. |
The annual limit for the 2023 tax year is $6,500. If you’re age 50 or older you can contribute an additional $1,000. |
|
Employer match |
Varies by employer, with average match of 4.5%.1 |
None. |
None. |
|
Investment selection |
Generally chosen by your employer; more than one type of portfolio may be offered. |
You can choose the investments for your portfolio. |
You can choose the investments for your portfolio. |
Eligibility
401(k)
Most employers have certain qualifications you must meet to participate in their 401(k) savings plan, such as being at least 21 and employed with the organization for at least one year.
Traditional IRA
Anyone with earned income.
Roth IRA
You must meet certain contribution criteria and tax filing requirements.
Contribution details
401(k)
401(k) contributions are directly withdrawn from your paycheck with pre-tax dollars.
Traditional IRA
Traditional IRAs can be funded with after-tax dollars or as tax-deductible contributions.
Roth IRA
Roth IRAs are funded with after-tax dollars.
Annual contribution limit
401(k)
The annual limit for 2023 is $22,500. If you’re age 50 or older you can contribute an additional $7,500.
Traditional IRA
The annual limit for the 2023 tax year is $6,500. If you’re age 50 or older you can contribute an additional $1,000.
Roth IRA
The annual limit for the 2023 tax year is $6,500. If you’re age 50 or older you can contribute an additional $1,000.
Employer match
401(k)
Varies by employer, with average match of 4.5%.1
Traditional IRA
None.
Roth IRA
None.
Investment selection
401(k)
Generally chosen by your employer; more than one type of portfolio may be offered.
Traditional IRA
You can choose the investments for your portfolio.
Roth IRA
You can choose the investments for your portfolio.
IRA vs. 401(k) taxes and withdrawals
401(k)s and traditional IRAs have more in common when it comes to tax benefits, distribution and withdrawal requirements. They’re considered tax-advantaged investment accounts, since contributions are either pre-tax or tax-deductible.
A Roth IRA is considered a tax-free investment account, since distributions and qualified withdrawals aren’t taxed.
|
|
401(k) |
Traditional IRA |
Roth IRA |
|---|---|---|---|
|
Tax implications |
Pre-tax or tax-deductible contributions. Withdrawals taxed as ordinary income. |
Pre-tax or tax-deductible contributions. Withdrawals taxed as ordinary income. |
Non-deductible contributions. Tax-free withdrawals on contributions; tax-free withdrawals on earnings if you’ve owned the account for five years. |
|
Tax penalties for early withdrawal |
10% penalty tax if withdrawn before age 59 ½, but certain exceptions may apply to your situation. |
10% penalty tax if withdrawn before age 59 ½, but certain exceptions may apply to your situation. Qualifying exceptions include first-time homebuyers, college and medical expenses. |
If you're younger than 59 ½, you can withdraw up to $10,000 penalty-free to pay for qualified first-time home-buyer expenses, provided at least five tax years have passed since your initial contribution. Other exceptions may apply to your situation. |
|
Required minimum distributions (RMDs) |
Effective beginning 2023, you must begin taking required minimum distributions (RMDs) at age 73. You're required to withdraw a certain amount each year, calculated based on your age and the value of your accounts. |
Effective beginning 2023, you must begin taking RMDs at age 73. You're required to withdraw a certain amount each year, calculated based on your age and the value of your accounts. |
No minimum distributions required during the Roth IRA account owner or spouse’s life. Read about distribution requirements for an inherited IRA. |
Tax implications
401(k)
Pre-tax or tax-deductible contributions. Withdrawals taxed as ordinary income.
Traditional IRA
Pre-tax or tax-deductible contributions. Withdrawals taxed as ordinary income.
Roth IRA
Non-deductible contributions. Tax-free withdrawals on contributions; tax-free withdrawals on earnings if you’ve owned the account for five years.
Tax penalties for early withdrawal
401(k)
10% penalty tax if withdrawn before age 59 ½, but certain exceptions may apply to your situation.
Traditional IRA
10% penalty tax if withdrawn before age 59 ½, but certain exceptions may apply to your situation. Qualifying exceptions include first-time homebuyers, college and medical expenses.
Roth IRA
If you're younger than 59 ½, you can withdraw up to $10,000 penalty-free to pay for qualified first-time home-buyer expenses, provided at least five tax years have passed since your initial contribution. Other exceptions may apply to your situation.
Required minimum distributions (RMDs)
401(k)
Effective beginning 2023, you must begin taking required minimum distributions (RMDs) at age 73. You're required to withdraw a certain amount each year, calculated based on your age and the value of your accounts.
Traditional IRA
Effective beginning 2023, you must begin taking RMDs at age 73. You're required to withdraw a certain amount each year, calculated based on your age and the value of your accounts.
Roth IRA
No minimum distributions required during the Roth IRA account owner or spouse’s life. Read about distribution requirements for an inherited IRA.
Is an IRA or 401(k) better suited for your needs?
- Consider a 401(k) if your employer offers a company match and you prefer to contribute to an account with pre-tax dollars.
- If your priority is to lower your taxable income, a traditional IRA can help with that. Whatever you contribute, your taxable income may be lowered by that amount.
- If flexibility is a priority, consider a Roth IRA. With qualified tax-free withdrawals in retirement, no required withdrawals and the ability to withdraw your contributions at any time, Roth IRAs make cashing out easy.
Diversifying your investments can lower your taxes now and into retirement. Learn more in this guide to tax diversification and investing.
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