Two of the most popular types of retirement accounts are the 401k and the IRA. They both offer tax advantages but have different eligibility rules, contribution limits, withdrawal rules, and investment options.

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Main differences between a 401k and IRA

  • Type of account: A 401k is employer-sponsored and an IRA is an individual retirement account.
  • Eligibility: To contribute to a 401k, you need to work at a company that offers a 401k plan. Anyone with earned income can contribute to an IRA (a Roth IRA has income limits that restrict high earners from contributing).
  • Contribution limits: A 401k has a contribution limit of $20,500 ($27,000 if age 50+) for 2022 and $22,500 ($30,000 if age 50+) for 2023. An IRA has a contribution limit of $6,000 ($7,000 if age 50+) for 2022 and $6,500 ($7,500 if age 50+) for 2023.
  • Investment options: An IRA has much more investment options, allowing you to invest in a wide range of individual stocks, mutual funds, bonds, and ETFs. You can also invest in alternative assets with a self-directed account. With a 401k, you can typically only choose from a small list of mutual funds.
  • Loans: With a 401k, you can borrow up to 50% of your plan value up to a maximum of $50,000. You get 5 years to pay the money back and interest rates are set at prime rate plus one or two percent. There is no loan option with an IRA.
  • Employer match: Many 401k plans come with an employer match, where your employer will contribute to your 401k up to a specified amount. 401k matches are basically free money on top of your salary and should always be prioritized. There is no matching contributions for an IRA.
  • Withdrawal rules: You must be at least 59½ years old in order to take distributions from a 401k or IRA without any penalties. The Roth IRA lets you withdraw contributions at any age without penalties. To withdraw earnings, you must be at least 59½ years old and your Roth IRA must be at least 5 years old.

The rest of the article below will expand on these differences.

Eligibility differences

A 401k is an employer sponsored plan and must be established by your employer. In order to be able to contribute to a 401k, you need to work at a company that offers one for their employees. An individual cannot open a 401k on their own, unless they’re opening a solo 401k.

An IRA is an individual retirement account and can be established on your own without an employer. Anyone with earned income can open and contribute to an IRA, whether that’s a traditional IRA or a Roth IRA.

Can I contribute to both at the same time?

Yes, you can contribute to both a 401k and an IRA at the same time. Contributions to a 401k don’t affect your IRA contribution limits, and vice versa.

IRA income limits

An IRA has two different accounts: A traditional IRA and a Roth IRA. They both have income limits that work a little bit differently.

A Roth IRA restricts you from contributing if your income is too high.

Roth IRA income limits for 2022

  • If your MAGI is $129,000 or less, you can contribute up to the maximum Roth IRA contribution limit of $6,000 ($7,000 if age 50+).
  • If your MAGI is over $129,000 but less than $144,000, your contribution limit gets reduced.
  • If your MAGI is over $144,000, you cannot contribute at all.

To be able to make the full contribution into a Roth IRA for 2022, your income must be under $129,000.

Roth IRA income limits for 2023

  • If your MAGI is $138,000 or less, you can contribute up to the maximum Roth IRA contribution limit of $6,500 ($7,500 if age 50+).
  • If your MAGI is over $138,000 but less than $153,000, your contribution limit gets reduced.
  • If your MAGI is over $153,000, you cannot contribute at all.

To be able to make the full contribution into a Roth IRA for 2023, your income must be under $138,000.

Unlike a Roth IRA, there are no income limits with a traditional IRA. However, tax deductions could get reduced to zero if you also receive a 401k or other retirement plan at work.

Traditional IRA tax deduction limits for 2022

  • If your MAGI is $68,000 or less, you get get a tax deduction up to the maximum traditional IRA contribution limit of $6,000 ($7,000 if age 50+).
  • If your MAGI is over $68,000 but less than $78,000, you’ll get a partial tax deduction.
  • If your MAGI is over $78,000, you get no tax deduction.

To be able to get the full tax-deduction on your contributions for 2022, your income must be under $68,000.

Traditional IRA tax deduction limits for 2023

  • If your MAGI is $73,000 or less, you get get a tax deduction up to the maximum traditional IRA contribution limit of $6,500 ($7,500 if age 50+).
  • If your MAGI is over $73,000 but less than $83,000, you’ll get a partial tax deduction.
  • If your MAGI is over $83,000, you get no tax deduction.

To be able to get the full tax-deduction on your contributions for 2023, your income must be under $73,000.

You’re still allowed to make contributions into a traditional IRA even if your income is too high but you get no tax deductions.

Contribution limit differences

The contribution limit for a 401k plan is much higher than for an IRA.

  • The 401k contribution limit is $20,500 for 2022 and $22,500 for 2023. If you’re at least 50 years old, you can contribute up to $27,000 for 2022 and $30,000 for 2023.
  • The IRA contribution limit is $6,000 for 2022 and $6,500 for 2023. If you’re at least 50 years old, you can contribute up to $7,000 for 2022 and $7,500 for 2023.

The 401k and IRA both have a Roth option. With an IRA you can open a traditional and a Roth IRA at the same time. With a 401k, you can only contribute to a Roth 401k if your plan provider offers one. Not all employers include a Roth option with their 401k plans. If they don’t offer one, you’ll only be able to contribute to a traditional 401k with pre-tax dollars.

The contribution limits for a Roth and traditional account are the same. You can contribute to both accounts but your total contributions must not exceed the contribute limit that’s been set for the year.

What’s the difference between a Roth and traditional plan?

The main difference between the two accounts is when you get a tax break.

  • With a traditional 401k or IRA, you get a tax break upfront when you make your contribution. Your contributions are made in pre-tax dollars, and get deducted from your taxable income. However, your withdrawals in retirement are taxed as regular income. For example, if you made $50,000 this year and decide to contribute $5,000, your new taxable income is $45,000.
  • With a Roth 401k or IRA, you get a tax break when you withdraw money. Your contributions are made in after-tax dollars, not deducted from your taxable income. However, your withdrawals in retirement are completely tax-free. For example, if you made $50,000 this year and decide to contribute $5,000, you would do so after paying taxes on the full $50,000 of taxable income.

Investment options

A 401k plan usually has the least amount of investment options to choose from out of any retirement plan.

  • With an IRA, you can invest in individual stocks, ETFs, mutual funds, and bonds (depending on your plan provider).
  • With a 401k, you’re usually limited to around 8 to 12 mutual funds that your company selects for their plan. You can’t invest in individual stocks, or alternative assets.

You can also choose to open a self-directed IRA if you’re looking to invest in alternative assets like crypto, real estate, and private equity. While a self-directed 401k exists, it’s very rare for a company to offer them.

Loans

If your 401k plan provider enables the option, you’re allowed to take a 401k loan. There is no such thing as an IRA loan.

A 401k loan lets you borrow up to 50% of your account’s value, up to a maximum of $50,000. Interest rates are set at prime rate plus one or two percent. The good part is that all interest payments go straight back into your account. The bad part is that a loan depletes your retirement account of funds that would otherwise be invested.

How long do I have before I have to pay it back?

When you take a 401k loan, you have 5 years to pay back the money into your account, including all interest. If you use the money to purchase a primary residence, you may be able to get up to 15 years to repay the money. Some plan providers will not let you make any additional contributions until your loan is repaid, so make sure to check your plan provider’s loan policies first.

Does an IRA have a loan option?

An IRA does not have a loan option. The closest alternative option would be to do an indirect rollover, also known as a 60-day rollover.

Withdrawal rule differences

Both the 401k and IRA have similar withdrawal rules. You can start taking distributions from your account, without any penalties, when you reach the age of 59½. Any withdrawals made before the age of 59½ are subject to a 10% penalty tax, plus income taxes.

For example, if you withdraw $20,000 from a 401k or IRA before the age of 59½, you’ll have to pay $2,000 in penalties and pay income taxes on the $20,000 withdrawn. The amount in taxes you’ll pay depends on your tax bracket and tax rates at the time of withdrawal.

The Roth IRA has slightly different withdrawal rules

With a Roth IRA, you’re allowed to withdraw your contributions from your account without penalties at any age, even if you’re under the age of 59½.

However, to withdraw any earnings from your account, you must wait until you’re at least 59½ years old, and your Roth IRA must be at least 5 years old (at least 5 years must have passed since your first contribution).

Employer matching

A 401k could have employer match contributions, while there’s no such thing as an IRA match since it’s not an employer-sponsored plan. Companies that offer a 401k match will make contributions to an employee’s 401k plan up to a percentage of salary.

For example, a common employer match structure is: Dollar-for-dollar matching up to 5% of salary. In this case, if you make a $100,000, your employer will match your contributions dollar-for-dollar (they’ll put in $1 for every $1 you put in) up to a maximum of $5,000 (which is 5% of your salary). In order to receive the match, you’ll have to contribute at least $5,000 yourself.

Employer match contributions to a 401k are essentially free money on top of your salary and maximizing your match each year should be the first priority if you have both a 401k and an IRA.

Also read: What Is The Average 401k Match?

Which account should I contribute to first?

The answer mainly depends on if your 401k plan offers employer match contributions. 401k matches are basically a 100% return on your money. For example, in a dollar-for-dollar match, you contribute $5,000 to receive $5,000 from your employer. Some companies may choose to do a partial match of $0.50 on the dollar where you’ll receive $2,500 for contributing $5,000.

If your company offers an employer match, you should prioritize putting in at least enough money to receive the maximum 401k match. If they don’t offer any 401k match, maxing out your IRA first can be the better option since you have access to more investment options. Once you max out your IRA, you can resume contributions to your 401k.

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