It is very important to make the financial provisions for your post-retirement life. 401k and IRA are two retirement saving plans available for the workers in the USA. Read on to know the basic differences between these two plans.
A person may make a lot of money in his working days, but the money won’t last forever, until he chooses an appropriate retirement plan. 401k and IRA (individual retirement account) are two retirement plans allowed under the tax law of the United States. In the 401k plan, a worker can deposit the invested savings, which are not liable to current income tax until withdrawal. Whereas, individual retirement account or IRA enables the worker to avail some tax advantage options for the retirement savings. These two plans differ from each other in some more ways.
The basic difference between these two plans is, 401k plan is set by the employer; whereas the IRA plan is set by the employee.
In 401k plan, an employee has to start withdrawing the funds at the age of 70 years and 6 months, unless he is still employed, or the penalty amounting to 50% of the minimum distribution is applicable. In IRA plan, the plan owner has to start withdrawing his money at the age of 70 years and 6 months, irrespective of his working status. Otherwise, a penalty amounting to 50% of the minimum distribution is applicable.
If the employee under the 401k plan changes his employer, his retirement plan can also be changed. He can switch to either another employer’s 401k plan or the traditional IRA plan in an independent company. The employee under a traditional IRA plan, transfers the fund money to another company in a rollover contribution, within a period of 60 days. The retirement plan can be converted to IRA or Roth IRA, after the termination of the employment. The employee has to pay taxes during the year he changes the plan from 401k to Roth IRA. In the IRA plan, though there are a few limitations, it can be changed to Roth IRA, but the employee has to pay taxes during that year.
In 401k plan, the employee cannot make payment for the secondary education for himself, his spouse, or his children in the last 12 months of his service, or else it is subjected to 10% penalty. In the section of home down payment, buying primary residence and avoiding foreclosure, dispossession of primary residence is also subjected to 10% penalty. Medical expenses either for the employee, spouse, or dependents, that are not covered by insurance are subject to 10% penalty.
|Income limits||Controlled by HCE (highly compensated employee) rules, but usually no limits.||Single, HoH, MFS: full contribution to USD 53k, partial to USD 63k; MFJ; QW: full contribution to USD 85k, partial to USD 105k; depending upon MAGI (Modified adjusted Gross Income). One can not invest more than he earns in a year.|
|Tax Implications||Though contributions are tax deferred, later they are taxed at regular income bracket for distributions.||Contributions are first post-tax money. Tax basis for each tax year is reduced, because the contributions are tax deductible. Later, distributions are taxed at regular income tax for distributions.|
|Matching Contributions||Available from the employers.||Not available.|
|Contribution Limits||It is USD 16.5k per year for the person of age below 50 and USD 22 per year for the person of age 50 and above in the year 2009. Employer and employee’s combined contribution should be lesser than either USD 46k or employee’s 100% salary. (Traditional 401k and Roth 401k plan’s combined total contribution limits are given.)||It is USD 5k per year for the person of age 49 or below and USD 6k per year for the person of age 50 or above in the year 2009. (Traditional IRA and Roth IRA plan’s combined total contribution limits are given.)|
|Contribution Withdrawal||Only loans are available depending upon the employer’s plan.||Not available.|
|Early Withdrawal||Taxes including hardship withdrawals, subject to additional 10% penalty.||Taxes for distributions before age 59 years and 6 months (with some exceptions), in addition with 10% penalty.|
In the IRA plan, the owner can withdraw money for a qualified higher education for himself, his children, and grandchildren. For the first time home purchase down payment, employee gets to withdraw up to USD 10k, with stipulations. He can withdraw money in case of a disability, for any qualified unreimbursed medical expenses (should not be more than 7.5% of AGI), or medical insurance, during the period of unemployment. In case of the death of the owner, the spouse can roll both accounts into one IRA account. Estate tax is not applicable, if the inheritance is under the exemption amount. Other donees will be subject to forced taxable distributions of funds based on their life expectancy.
These are the basic differences between 401k and IRA. You can choose either or both the plans. Consult your financial adviser before choosing a retirement plan in order to have a financially well-secured life.