What Is the Difference Between an IRA and a 401(k) Plan?

Every day, the need to save money for the future seems to get more important. Most individuals have some money set aside for a rainy day, but not everyone has considered saving for retirement. When it comes to retirement savings plans, two of the most popular options are IRA and 401(k) plans. IRA stands for Individual Retirement Account, and it differs from the 401(k)-retirement savings plan. At a glance, both offer tax-deferred growth of your investment and allow you to make contributions with pretax dollars. However, they also have a few key differences:

Management of the Account

The major difference between IRA and 401k is who manages the account. With an IRA, you are in control of your account and can choose which investments to make. With a 401(k) plan, however, your available investment options are chosen and determined by the employer.

Your employer may also have the ability to match a certain percentage of your contributions, which can make a 401(k) plan a more attractive option. This can be seen as both an advantage and a disadvantage, based on how you feel about managing your own finances. Some people like having the control that comes with an IRA, while others prefer to leave the investment decisions up to someone else.

Contribution Limits

Another key difference between the two is the contribution limit. In 2021, the contribution limit for an IRA was $6,000 per year (or $7,000 if you are over age 50). The contribution limit for a 401(k) plan is much higher, at $19,000 per year (or $25,000 if over the age of 50). This can make a 401(k) plan a better option if you are looking to save significant amounts for retirement. However, this plan more than often carries higher fees compared to IRAs.

Withdrawal Rules

The rules for withdrawals are also different between the two plans. With an IRA, you can start taking withdrawals at any time after age 59 1/2 without worrying about penalties. With a 401(k) plan, you generally have to wait until you retire or leave your job to start taking withdrawals without paying a penalty.

However, there are some circumstances where you can take early withdrawals from a 401(k) plan without paying a penalty, such as if you become disabled or need the money to pay for medical expenses. If you do take an early withdrawal from a 401(k) plan, you will generally be required to remit taxes on the amount withdrawn.

Conclusion

In conclusion, there are some key differences between an IRA and a 401(k) plan that you should be aware of before selecting your plan. An IRA offers more control over your investments, while a 401(k) plan has higher contribution limits. Withdrawal rules also differ between the two types of accounts, with an IRA allowing you to take withdrawals at any time after age 59 1/2 without paying a penalty. Ultimately, the best savings plan is the one that helps meet your retirement financial goals.