- 1 1. what are the main differences between a 401k and a roth ira?
- 2 What Are The Differences Between an IRA and a 401k
- 3 Building Wealth: 401(k) vs. Roth IRA – Know the Difference and Your Options
- 4 The Difference between Roth IRA and Traditional IRA
- 5 What’s the Difference Between a 401(k) and an IRA? Which is Better?
1. what are the main differences between a 401k and a roth ira?
A SARSEP IRA is a Salary Reduction Simplified Employee Pension plan that is used in companies with fewer than 25 employees. In order to set up such an account, the employer must have at least 50% of the eligible employees contribute to this plan. Employees may make contributions in pre-tax dollars and deduct these amounts from their current income through salary reduction, thus reducing their current tax burden while saving for their retirement. After 1996, these plans were replaced by Simple IRAs. Some employers still use pre-1996 plans.
A Simple IRA allows employers with fewer than 100 employees who earned $5,000 and above to save for their retirement.
How much may an employee contribute to a Simple IRA?
In 2013 and 2014, employees may contribute (or defer) up to $12,000 of their salary per year, and set this money aside for retirement. Employers may also match up to 3% of each employee's income into this account.
In a Roth IRA, contributions are made with after-tax dollars, meaning the income of your paycheck after your employer deducts income taxes. You may make these non-tax-deductible contributions to a Roth IRA up to a certain limit each year. Under certain circumstances, you may withdraw money from this account tax free before retirement, and you can withdraw all of it tax-free after age 59!4. You may continue to add to this account up to the annual limit for as long as you like. You currently do not have to pay taxes on any distributions from this account, so that your money may grow tax free.
What is the difference between a Roth IRA and a Roth 401 (k)?
A Roth 401(k) allows people to divert up to $17,000 annually (as of 2014) if they are under 50 and $22,500 if they are over 50, while a Roth IRA allows for $5,500 a year for those under 50 and $6,500 for those over. A Roth IRA may exist indefinitely and be passed down to the next generation, while you must start taking distributions for a Roth 401(k) beginning at age 70%.
What Are The Differences Between an IRA and a 401k
The IRA and 401k are both types of programs established with the intent of allowing long term tax advantaged savings for your retirement years. They have similarities in how they are taxed, but differences in availability, provisions, and requirements.
An IRA is an Individual Retirement Account that was first permitted under the Employee Retirement Income Security Act of 1974. The intent of the IRA was to allow individuals not covered under company pension or profit sharing programs to set up an account for their retirement.
The original plan, the Traditional IRA, allowed you to contribute $2,000 into a bank or brokerage account, and take a tax deduction for these contributions on your tax return. In exchange, eventual withdrawals were totally taxable when you retired. Since 1974, the limit on contributions has grown to $5,000 per year ($6,000 if you over age 50 when you make the contribution).
Also, in 1997 Congress passed a bill creating the Roth IRA. This type of IRA allows you to put in after-tax contributions of $5,000, but all withdrawals are totally tax free at retirement or after age 59 ½.
The 401k was designed for companies as an alternative, or an addition, to pension and profit sharing plans. Most large companies initially set up a 401k plan to supplement the existing pension plan. These plans allowed employees to contribute a percentage of salary, usually 3% – 5%, and the company would match all or a portion of the employee contribution.
Both IRA’s and 40k’s became very popular methods of saving and are still the most widely used plans today. Let’s look at some of the primary differences between the two concepts.
The primary difference between and IRA and a 401k is the availability for you to use these types of plans. An IRA is available to all workers who have earned income and are under age 70 ½. While you may be eligible, you may not be able to contribute if your earnings are over certain limits. These limits also change depending upon if you are also covered under a company pension plan.
Another factor which alters the contribution limits is the type of IRA you set up, either Traditional IRA or Roth IRA.
The 401k plan is only available to workers whose employer has established such a plan. Many companies have pension plans and no 401k plans. Alternatively, companies have 401k plans, but no pension plans. So you can’t just go out and join a 401k. You employer must offer this type of plan in their package of employee benefits.
The annual IRA contribution limit for 2011 is $5,000 per year or $6,000 if you are over age 50. This is a relatively small amount if the IRA is you only means of saving for retirement.
The 401k plan allows for much higher contribution maximums. Most corporate 401k plans will allow you to contribute between 1% and 8% of salary. You get the same tax deduction for these contributions as you do under the IRA, and withdrawals are totally taxed when made later on. The company may or may not contribute to the 401k plan. Most large corporate plans will match a portion of your contribution.
This matching program by your employer is essentially free money to you. Some employees do not contribute to a 401k plan since they do not feel they can afford to put in the contribution. However, not contributing is like refusing a salary raise due to you not getting the company matching contribution.
More recently, the 401k rules were changed to also allow companies to set up Roth 401k’s. These are similar to the Roth IRA where contributions are made with after-tax contributions and withdrawals are totally tax free after age 59 ½. Many companies simply let you decide if your contribution to the 401k will be considered Traditional contributions or Roth contributions.
Investing in an IRA gives you a lot of flexibility when deciding upon what to invest in. You can choose almost any normal types of investments. There are some limitations on IRA investments, but these are investments that you would not normally put your savings into in the first place.
In the 401k plan, your employer decides what investments will be appropriate to offer employees. These will most times be a selection of mutual funds or individually managed funds. The plan might only give you a choice of 5 or so funds, such as 1or 2 stock funds, a bond fund, a money market fund and a company stock fund. This severely limits your flexibility when investing your money.
Some plans may offer 30 – 40 different mutual funds for you to select from. This gives you more flexibility, but many of the funds still may not meet your investing style.
When thinking of investments, the IRA clearly gives you more flexibility. However, the lack of flexibility is not a reason to stop contribution to a 401k since you might be foregoing the company matching contributions.
Both the IRA and 401k allow you to stop participating and withdraw your money at any time. Both are subject to similar tax rules when comparing Traditional IRA and Traditional 401k, or Roth IRA and Roth 401k.
The 401k allows you to borrow some of your money out of the plan, without it being a taxable event. Such a loan, however, carries risk. If you spend the money and do not pay back the loan in installments, the entire amount may become taxable. So you may get hit with taxes after you already spent the amount you withdrew.
The IRA has no loan provisions. You cannot borrow against your IRA or use the IRA as collateral for a loan. The only way to get money out is to make an actual withdrawal, and trigger a taxable event.
You might be able to utilize both a 401k and IRA to save for retirement. The decision is based on your salary level, the type of plans you are covered under, and the type of IRA you want to set up.
There are simply too many factors involved with IRA’s and 401k’s to describe in one brief article. It really takes an entire book. These factors include what type of plans you have at work, your salary level, your goals, flexibility needed. All of these then differ if you are considering one of the two main IRA options (see Roth IRA vs. a Traditional IRA for more information).
Suffice it to say that if you have a 401k plan at work, contribute at least the minimum amount to get the full company matching contribution. You can look to see if you can also open an IRA for additional savings.
If you do not have a 401k plan at work, look then to either a Roth or Traditional IRA as your means for retirement saving.
Building Wealth: 401(k) vs. Roth IRA – Know the Difference and Your Options
This post was hand-picked for you, and may contain affiliate links for your convenience. See our disclosure policy.
How old are you? Do you earn a monthly income? Do you know the difference between a 401k vs. Roth IRA? The average American will contribute to one or the other or perhaps even both in their lifetime. I have one of each for myself, for different reasons and I’ll tell you why.
Let me tell you a story first: After my grandfather returned home from his service in WWII and the Korean War, he worked the remainder of his life in a cement factory – a cement factory that offered a pension plan. He passed away young and when he did, he left my grandmother that sizable monthly pension that she then used in addition to her social security. No retirement account to speak of.
After raising eight children as a stay-at-home mother (homemaker in those days!) with the last of my uncles leaving home when she was around sixty-three years of age, my grandmother simply could not have enjoyed her comfortable lifestyle without my grandfather’s pension – that she received monthly for over 20 years after his death in the late 80’s.
Before we get into the specifics of each of these retirements plans, it is important to realize that work pensions are quickly becoming a thing of the past . If you’re wanting to retire – and before the age of 75 – you are going to have to plan for this yourself.
Do not rely on your possible inheritance, do not rely on your employer (although if they match your contribution you definitely want to capitalize on that – more on that later), do not rely on Social Security, do not rely on anyone or anything but yourself. Even if you are “only” twenty-five years old, NOW is the time to start – you’re in this for YOU and you’re in it for the long haul. You’ll thank yourself later.
Before deciding whether to go with a Roth IRA (Individual Retirement Account) or a 401(k), you’ll want to ask yourself two basic questions:
- Will my employer match any contributions that I make?
- Do I want to pay taxes NOW or LATER?
You’re going to either pay your taxes before you contribute to the retirement account plan or you’re going to pay when you withdraw your funds (a.k.a. when you retire ). Uncle Sam will get his portion here or there. Which route will you take?
A Roth IRA is an Individual Retirement Account that you set up directly with an investment firm. You tell them how aggressively you want them to invest your money. Whether you are on the conservative side, moderate or you are aggressive with investing your funds is completely up to you.
With a Roth, you’ll make your contributions after taxes are taken out of your income – ie: straight from your own pocket/checking account after depositing your paycheck. When you reach age 59 1/2 and you have had your Roth IRA for at least five years, you can then withdraw your funds (both investment gains and deposits) completely tax free – because you had already paid taxes on that income when you received your paycheck way back when.
Ask yourself: do I see myself in a much higher tax bracket (more income) when I retire than I am currently?
Example: If you are 25 years old and sitting in the 15% tax bracket now, by the time you retire are you expecting to be in the 25% or higher tax bracket? If so, you could be paying considerably more in taxes when you withdraw your funds than you would if you paid in taxes now.
There is also a maximum amount you can contribute per year to your Roth IRA ($5,500 in 2016 for those under age 50) with a few exceptions. You’re going to want to visit with your financial adviser for more detailed information but suffice it to say that unless you are contributing more than $450 (ish) per month (go you!) you don’t have much to worry about.
A bonus to a Roth IRA is that you get to pick with whom you work. You pick the firm, the representative. You may also retrieve any of your contributions (not investment earnings, contributions only) at any time without being penalized.
A 401(k) is a retirement account offered through your place of employment. This is typically offered as a group benefit, so you are going through the investment/brokerage firm of your employer’s choosing. You will have options within the plan just as you do in a Roth, except that when your employer cuts your paycheck, they take the funds out before income tax and send them to be deposited into your personal plan.
Start with $25 or $50 per paycheck – or as much as you can manage. The point is that you’re doing it. Small amounts add up to big amounts, especially if you are young and have another 30-40 years of work (contributing) before you.
Since they take it out pre-tax, the amount that this affects your paycheck is less than you might think. If you have them withhold $50 per paycheck, that may only feel like $40 when all is said and done. Again, just an example but you get the idea.
If your employer offers to match your contribution, some match 3%, some 5%, some 6% (the higher the better!) and you are not contributing, you are turning down (think: wasting) free money by not taking advantage of this benefit.
If your EMPLOYER will match your contribution up to 5% of your gross salary, and YOU are contributing 5% of your gross salary, that is 10% of every month’s gross (pre-tax) earnings going straight into your 401(k).
Example: let’s say your pay checks are $1,500 gross (before taxes) every two weeks. That is $3,000 gross (before taxes) per month, your 5% contribution would be $150 and if your employer matches up to 5%, they are also adding $150 to your $150. This means that $300 per month is being deposited into your 401(k) account. Keep in mind that this only feels like $125 (huge estimation here) since you are not taxed on this income yet. You get the drift.
When you reach retirement age, and you go to withdraw your funds, you will then pay tax on that money – at your retirement-age tax rate.
A bonus to the 401(k) instead of Roth is that you could get a tax break during the year that you contribute, each and every year. While there is a limit to how much you can contribute each year as well ($18,000 in 2016), you are allowed to make much higher contributions to a 401(k) vs. a Roth (about three times as much!).
There are many options and restrictions to consider when choosing a Roth IRA vs. 401 (k), so you’ll definitely want to visit with your financial adviser before making any final decisions or setting up an account.
I have my Roth account to deposit small amounts throughout the year and to deposit into if needed for tax purposes, and my 401(k) through my employer to take advantage of their match.
No matter which option you choose, the point is that you are doing it. You are planning for your future, you’re being an adult about it, and you’re ultimately going to retire young(er) as a result. Go you!
There's more where this came from! Ready for CROCHET tips, YARN hacks and crochet PATTERNS sent directly to your inbox?
Welcome! Be sure to check your email, cause your inbox just got more fun. Redirecting you back .
The Difference between Roth IRA and Traditional IRA
Have you ever wondered what is the difference between a Roth IRA and a Traditional IRA? You would not have been the first person to ask. They can both be effective tools for helping people save money for retirement, but they do have different characteristics. One plan is better for people that are looking to lower their taxable base now and the other is better for people that are looking to lower their taxable base later. Let’s take a look at the difference between Roth IRA’s and Traditional IRA’s.
Traditional IRA’s are tax deferred plans that allow you to make contributions from your pretax income. This has the effect of lowering your taxable income and allowing you to gain tax free growth. Traditional IRA account holders pay less in taxes today based on the hope of taxes being at a much lower rate in the future.
In order to qualify for a Traditional IRA, you have to meet two criteria. First, you must be under the age of 70 ½. Secondly, you must have some documented form of compensation. Contributions are maxed at $5,000 for anyone under the age of 50 or $6,000 for anybody 50 and over.
Since Traditional IRA account holders do not pay taxes on their contributions, they do have to pay taxes on their withdrawals. Account holders are required to start taking minimum distributions on their funds by the age of 70 ½. All withdrawals are subject to the income tax rates of the time they are taken out.
Roth IRA’s are tax advantaged plans in which you forego a tax deduction today in order to withdraw your money tax free down the road. All contributions are made from after tax income. In general, Roth IRA account holders prefer to pay their taxes today since they believe that tax rates will be higher in the future.
In order to participate in a Roth IRA, you just need to have some documented form of compensation. This can be in the form of wages, tips, or even alimony. Just like with a Traditional IRA, you can contribute up to $5,000 a year if you are below the age of 50 or $6,000 annually if you are older than 50.
Main Difference between Roth IRA and Traditional IRA
One big difference between Roth IRA’s and Traditional IRA’s are that all earnings and contributions taken after the age of 59 ½ are income tax free with a Roth IRA.
Also, with a Roth IRA, you can take out your own contributions penalty-free at any time. For example, if you contributed $5,000 a year for 3 years and had $16,500 total when a big emergency hit, you could withdraw up to $15,000 penalty-free. The trick is that you can’t pay yourself back though after making an early withdrawal.
Finally, there are no required distributions for Roth IRA’s.
I personally contribute to my 401(k) and a Roth IRA. In fact, my husband fully funds a Roth IRA too. We figure that diversity is a good thing in most aspects of life – especially when saving for retirement.
What’s the Difference Between a 401(k) and an IRA? Which is Better?
This article may contain affiliate links. Read our Disclosure Policy
A 401(k) and Individual Retirement Account (IRA) are both retirement investment vehicles, but they don’t function quite the same.
While either will get you closer to funding your golden years, one might be more advantageous depending on your situation.
Unfortunately, you may not even have a choice between the two.
Here are the differences between a 401(k) and an IRA and how to tell which one might be better for you.
The reason I mentioned that you might not have a choice when it comes to picking a 401(k) or IRA is because 401(k)s are employer sponsored retirement plans. That means your employer must offer a 401(k) as part of your benefits package for you to have access to one.
A lot of smaller companies might not offer 401(k)s. That was the case for the first few employers I had, and as a result, I didn’t start saving for retirement until a few years after I landed my first full-time job.
The awesome bonus of 401(k)s over IRAs is that employers can also choose to match your contributions up to a certain percent. That means you get free money! This bonus is something that many young workers aren’t aware of because it tends to be in the fine print of their benefits package.
Ask your HR department (or whoever manages the 401(k) package at your company) for more information on this, as you don’t want to miss out and leave money on the table.
Anyone can open an IRA as long as they have earned income. You don’t need an employer to open an IRA for you. So no excuses for skipping out on retirement contributions if a 401(k) isn’t available to you!
However, there are exceptions you need to be aware of that are beyond the scope of this article. Suffice to say if you earn over a certain amount, depending on your tax filing status, you may be limited to how much you can contribute.
But if you’re a younger and still working your way up the ladder, you probably don’t have to worry about it as you tend to need a modified adjusted gross income of over $100,000.
Speaking of contributions, as of the 2016 tax year, you may contribute up to $18,000 in a 401(k). You’re limited to a contribution of $5,500 in an IRA.
$18,000 might seem like a lot, and the truth is, it might not be wise to focus on maxing out your 401(k). Not all 401(k)s are made equal.
For example, some come with a horrible selection of funds with extremely high fees. In this case, you might be better putting your money elsewhere so you can get a better return.
If this is the case for you, the good news is that you can contribute up to your employer match in your 401(k) and then switch over to contributing the rest of your money to your IRA. You don’t necessarily have to choose between one or the other.
401(k)s and traditional IRAs function similarly here – the difference is in how a Roth IRA is treated.
Contributions to 401(k)s and traditional IRAs are tax-deductible – they give you an immediate benefit when you file your taxes. When you contribute money to either of these accounts, your taxable income decreases since the contribution is made with pre-tax money.
401(k)s and traditional IRAs are tax-deferred, which means that you’re taxed when you withdraw the money in retirement. The benefit from this is that if your taxable income during retirement is lower, you might pay less than you would by saving in a Roth.
Tax-deferral also comes in handy when it comes to interest, as your money can compound freely. By contrast, you have to pay taxes on the interest gained in a savings or checking account.
Tax advantages with a Roth IRA are different. Instead of being taxed when you withdraw the funds, you’re taxed immediately upon making a contribution. However, withdrawals are tax-free.
By the way – some companies offer Roth 401(k)s, which work similarly to a Roth IRA, in case that’s an option for you!
The answer to this will greatly depend on your situation. Again, you might find that your 401(k) is abysmal. Maybe your employer doesn’t offer matching contributions, or maybe the match is limited. Or, maybe you don’t have access to a 401(k).
In any case, you can always open an IRA and make contributions to it, or contribute to both.
So then you run into the question: which is better, a traditional IRA, or a Roth IRA?
And again, the answer depends. I’m not a professional, and I don’t know your individual situation, so I can’t give you a definitive answer.
However, it’s been widely accepted that Roth IRAs can be a better choice for young adults. This is due to the fact that the money is tax-free when withdrawn.
The assumption is that you’re earning less right now while you build your career, so you’re likely in a lower tax bracket. As you age, your earnings will increase, and you’ll be in a higher tax bracket come retirement. Those withdrawals being tax-free will help lessen the burden.
Of course, this may not be the case for you, so you have to use your judgment. At the very least, you have a baseline for knowing which vehicle is better to invest in, so you can research more on your own.
There are other differences worth noting, too. For example, traditional IRAs require you to start taking distributions once you’re 70 1/2 years old, but maybe you have no reason to! Roth IRAs don’t require you to take distributions at any age, which means your money can continue growing tax-free until you’re ready to withdraw it.
Additionally, contributions to Roth IRAs can be taken before you’re 59 1/2 years old, without penalty, whereas you’ll pay a 10% penalty if you withdraw funds from a 401(k) or traditional IRA earlier than 59 1/2.
However, if you have a qualifying reason for a withdrawal, such as being a first-time homeowner, you can withdraw up to $10,000 from your traditional IRA without penalty. You must wait 5 “tax” years after making the first contribution to your Roth IRA before you can withdraw for a qualified expense.
As you can see, there is a lot of information to consider when thinking about which vehicle you should use for your retirement savings. There are so many little details when it comes to taxes that it can be a little overwhelming, but hopefully this provided a good baseline for you.
If you’re concerned about optimizing your taxes, I recommend speaking with an accountant or finance professional who can walk you through the best option for your situation.
Which is your pick – 401(k), traditional IRA, Roth IRA, something else? How did you come to that decision? Are you saving for retirement?
Join our online community and get the first chapter of our new book H ustle Away Deb t absolutely FR EE !