Differences between 401(k)s and IRAs
There are many key differences between 401(k)s and IRAs.
Establishment and setup: 401(k)s are employer-sponsored defined contribution retirement plans. Qualified employer may create these plans to offer an incentive for employees to save for retirement. The employee may select a percentage of their base pay, a Roth or pre-tax deferral, and a mutual fund investment for their plan. Plan features may include automatic enrollment, employer matching, and Roth contributions.
An individual retirement account is opened solely by an individual without an employer. An individual who works for an employer may still establish an IRA and contribute to the account. The individual must have earned income to make qualifying contributions during the year. Establishment may be completed through a broker, bank, or other financial institution.
Eligibility: Eligibility to contribute to a company 401(k) may depend on several circumstances, like age, service requirements, and part-time status. However, as far as income eligibility, there are no limits to the amount of income an individual may have to contribute to a 401(k) plan.
Eligibility to contribute to an IRA--Roth or Traditional--may be limited to household income levels and tax filing status. Earned income typically includes W-2 pay, like wages and salary, but is not limited to self-employment income, tips, or other active participation in work-related activity. Non-earned income examples are interest, dividends, capital gains, rental income, social security benefits, unemployment benefits, and more.
Contribution Limits: In 2024, the Internal Revenue Service (IRS) has set the pre-tax or Roth contribution limit at $23,000. This is the limit for employee contributions. Individuals over the age of 50 may make catch-up contributions of $7,500, making the total employee contribution limit of $30,500.
In 2024, the IRS has set the contribution limits for IRAs, both Roth and Traditional, at $7,000. Those individuals over the age of 50 may make catch-up contributions of $1,000, totaling to $8,000.
Investment Options: Investment options are typically limited in a 401(k) plan, with mutual funds being the main type of security. 401(k) plans will have a plan advisor who helps the employer sponsoring the plan to select certain funds for the plan participants. These pre-selected funds may be diversified by offering equity (stock), fixed income (bond), and money market options. Within the equity funds, there may be options for large, mid, and small caps funds, as well as international equity and fixed income options.
IRAs typically have greater flexibility than 401(k) plans. Depending on the brokerage firm or custodian, the range of investment options include stocks, bonds, mutual funds, electronic funds transfers, certificates of deposit, and more.
