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401(k) vs. an IRA & 401(k) vs. a Roth IRA: Understanding the differences

401(k) vs. an IRA and 401(k) vs. a Roth IRA

Forty years ago, people would stay with the same employer for decades and rely on a pension to provide them with an income stream that they could live on in addition to their Social Security benefits in retirement. In 1980, for example, 38 percent of workers were covered by pensions. By 2017, however, the Bureau of Labor Statistics reported that only 15 percent of Americans participated in pensions.

Pensions have largely been replaced by 401(k) plans, which transfer the risks of investment from the employers to their employees. 401(k) plans are employer-sponsored plans that workers can choose to participate in to save for their retirements. In addition to employer-sponsored 401(k) plans, people should also understand other types of retirement accounts, including IRAs and Roth IRAs, so that they can choose the savings vehicle that might help them the most.

401(k) vs. an IRA and vs. a Roth IRA

Statistics about a 401(k) vs. an IRA and 401(k)s vs. Roth IRAs

In the U.S., 42.6 million people have IRAs. Among people who report that they have IRAs, nearly 80 percent also report that they have defined contribution benefit plans through their jobs. An additional 29 percent of households in the U.S. report that they have employer-sponsored retirement plans but no IRAs. Altogether, 79 million Americans have some type of retirement plan.

Saving for retirement is important, and people should ideally start saving when they are young. It is important to understand the different types of retirement accounts, including a 401(k) compared to an IRA, so that you can choose the accounts that can help you to meet your goals.

What is a 401(k)?

A 401(k) plan is an employer-sponsored plan that is among the most well-known because many people have access to them through their jobs. For-profit employers and individuals can participate in 401(k) plans. When comparing a 401(k) to an IRA or a 401(k) to a Roth IRA, the 401(k) plan offers you the ability to contribute the most money each year. You can contribute up to $19,000 of your salary if you are under age 50 and an additional $6,000 per year if you are 50 or older.

Contributions to a 401(k) are made using pre-tax dollars. This helps to reduce your gross income and save money on your taxes during the years when you contribute. Your money can then grow tax-free in the account, and some employers offer matching contributions so that your money can grow even more.

There are a few downsides to a 401(k), however. You may have limited investment choices and may have to pay administrative, investment, and management fees. There are early withdrawal penalties of 10 percent if you withdraw money before you reach age 59 1/2, and you will pay taxes when you make withdrawals. When you reach age 70 1/2, you will have to begin taking required minimum distributions.

IRAs and Roth IRAs

IRAs and Roth IRAs are two other types of retirement plans. These are individual accounts that you can open. There are several different types of IRAs, including the following:

  • Traditional IRAs
  • SEP IRAs
  • SIMPLEs
  • Roth IRAs

Traditional IRAs and Roth IRAs are the most popular types. With a traditional IRA, your money goes in on a pre-tax basis similar to a 401(k). You are able to take tax deductions during the years in which you make contributions, and your money grows on a tax-deferred basis until you retire. When you do, you will pay taxes on your withdrawals at your ordinary income tax rate.

Contributions that you make to a Roth IRA are made after tax. Your savings can then grow tax-free until you retire. You will not have to pay taxes on your withdrawals after you retire, and you do not have to take required minimum distributions at age 70 1/2.

Why is it important to compare a 401(k) vs. an IRA and a 401(k) vs. a Roth IRA?

It is important to compare a 401(k) vs. an IRA and a 401(k) vs. a Roth IRA so that you can maximize your savings and the benefits that you can get from these different types of accounts. If you are able to do so, you can contribute to both a 401(k) and an IRA so that you can derive the greatest benefits.

By comparing these different types of accounts, you can determine where to put your money and whether you should consider rolling funds over from one type of account to another. This can help you to meet your financial goals when you retire and to possibly leave a legacy for your loved ones after you die.

401(k) vs. an IRA

401(k) vs. an IRA

To compare a 401(k) vs. an IRA, you must first understand the different types of IRAs that are available. While the two most popular types of IRAs are traditional IRAs and Roth IRAs, there are also some other types of IRAs that might be available to you through your employer.

The different types of IRAs may offer different annual contribution limits and tax benefits. They might also have different withdrawal rules. While most IRAs have required minimum distributions beginning at age 70 1/2, Roth IRAs do not. Here is some information about the different IRA types so that you can compare each type with a 401(k) account.

IRA or traditional IRA

An IRA is an individual retirement arrangement and is an account that has some similarities to a 401(k) in terms of the contributions. When comparing a 401(k) to an IRA, one of the first things to note is that contributions to both types of accounts are made on a pre-tax basis so that they reduce your income tax bill during the tax years in which they are made. Funds in both accounts are able to enjoy tax-deferred growth. You will pay taxes when you begin taking distributions to either a 401(k) or an IRA.

If you have an IRA, you hold it entirely. You will not receive matching contributions to the account. Since you are the sole owner of an IRA, you can choose which financial institution or brokerage firm will hold it. Since you will own the plan, choose your own investments, and pick the firm that will hold it, you should know how much your IRA costs you in terms of fees.

When you compare a 401(k) vs. a traditional IRA, you will see that IRAs have significantly lower annual contribution limits. If you are under age 50, you can contribute a maximum of $6,000 per year. If you are age 50 or older, you can contribute an additional $1,000 per year for a total annual maximum contribution of $7,000. You can begin taking distributions when you turn age 59 1/2, and you will have a required minimum distribution beginning at age 70 1/2. If you withdraw funds from your IRA before you reach age 59 1/2, you will be assessed an early withdrawal penalty of 10 percent unless an exception applies.

401(k) compared to an IRA

Understanding the differences between a 401(k) and an IRA can help you to determine whether you should invest in one over the other or possibly invest in both types of accounts. Here is a table to help you to understand the differences between a 401(k) and an IRA.

401(k) Traditional IRA
Pre-tax contributions Pre-tax contributions
Pay taxes when money withdrawn Pay taxes when money withdrawn
For individuals and employers For any individual
Contribution limit of $19,000 if younger than 50 Contribution limit of $6,000 if younger than 50
Catch-up contributions of $6,000 beginning at age 50 Catch-up contributions of $1,000 beginning at age 50
Penalties on withdrawals before 59 1/2 Penalties on withdrawals before 59 1/2
Required minimum distributions beginning at age 70 1/2 RMD beginning at age 70 1/2
Few investment choices Many investment options

While you can contribute more money to a 401(k) plan at your job, comparing a 401(k) vs. a traditional IRA demonstrates that you might have vastly more investment choices with a traditional account as opposed to a 401(k).

401(k) vs. a Roth IRA

401(k) vs. a Roth IRA

Comparing a 401(k) vs. a Roth IRA reveals that there are several important differences between a 401(k) and a Roth IRA. Some of the differences include how the contributions are made, who qualifies, the tax benefits, the withdrawal rules, and RMD rules.

Both of these accounts are retirement plans, and they each offer different advantages and disadvantages. Here is some information about the differences between a 401(k) and a Roth IRA so that you can understand how each of these two types of accounts works and the benefits that they might offer to you.

Roth IRA

A Roth IRA has several features that differentiate it from a 401(k) and a traditional IRA. When you compare a 401(k) vs. a Roth IRA, any individual can qualify to contribute to a Roth rather than being limited to employers and their employees. A 401(k) compared to a Roth IRA also has differences in how the contributions are made. In a 401(k), contributions go in pre-tax. By contrast, contributions to a Roth IRA go in after tax.

This means that you will be assessed taxes on withdrawals at the time that you make them from a 401(k), but you will not pay any taxes on withdrawals from a Roth IRA at the time of disbursement. The contribution limits for a 401(k) compared to a Roth IRA are also different. For a Roth IRA, people who are younger than age 50 may contribute an annual maximum of $6,000 per year. For people who are older than age 50, the maximum annual contributions to a Roth are $7,000.

You do not have to start taking required minimum distributions from a Roth at age 70 1/2. There are early withdrawal penalties of 10 percent from a Roth. However, some withdrawals are exempt from the penalties.

Differences between a 401(k) and a Roth IRA

Here is a table to help you understand how a 401(k) compares to a Roth IRA.

401(k) Traditional IRA
Pre-tax contributions Pre-tax contributions
Pay taxes when money withdrawn Pay taxes when money withdrawn
For individuals and employers For any individual
Contribution limit of $19,000 if younger than 50 Contribution limit of $6,000 if younger than 50
Catch-up contributions of $6,000 beginning at age 50 Catch-up contributions of $1,000 beginning at age 50
Penalties on withdrawals before 59 1/2 Penalties on withdrawals before 59 1/2
Required minimum distributions beginning at age 70 1/2 RMD beginning at age 70 1/2
Few investment choices Many investment options

401(k) vs. a Roth 401(k)

401(k) vs. a Roth 401(k)

Around half of employers that offer 401(k) plans to their employees offer both a traditional 401(k) and a Roth 401(k). The primary difference between a Roth 401(k) vs. a 401(k) account is how your contributions are made and when you will pay taxes on them.

If you have a Roth 401(k) vs. a 401(k) account, your contributions will be taken after you have paid taxes. When you begin taking disbursements, you will not be assessed any taxes. In a traditional 401(k) account, your contributions are made before tax, so they reduce your income and are able to grow on a tax-deferred basis until you begin taking withdrawals. You will pay taxes on your contributions at the time of your disbursements. Both types of accounts have required minimum distributions beginning at age 70 1/2.

What is a Roth 401(k)?

A Roth 401(k) is a special type of 401(k) account that allows you to make contributions on an after-tax basis instead of on a pre-tax basis. Many employers that offer employer-sponsored plans give their employees the choice between a Roth 401(k) and a traditional 401(k) plan. If your employer gives you the choice to choose a 401(k) vs. a Roth 401(k), it might make sense for you to hedge your bets and choose both types of accounts.

In a Roth 401(k), your contributions go in after tax, which means that you will not pay any taxes at the time of your disbursements. The contribution limits for both types of accounts are $19,000 if you are under age 50 and $25,000 if you are older than age 50. Many Roth 401(k) plans also offer company match programs. Like a traditional 401(k), you will have to begin taking required minimum distributions when you reach age 70 1/2. You can begin taking distributions at age 59 1/2 without penalty. The early withdrawal penalty for a Roth 401(k) is 10 percent. However, some withdrawals are exempt.

401(k) compared to a Roth 401(k)

A traditional 401(k) and a 401(k) Roth account have several similarities. Like a traditional 401(k), the Roth 401(k) limits are $19,000 per year if you are under age 50 and $25,000 per year if you are older than age 50. The higher Roth 401(k) contribution limits after age 50 are because of catch-up contributions of an additional $6,000 per year.

Both types of accounts have required minimum distributions when you reach age 70 1/2. However, a Roth 401(k) differs in when you will be assessed taxes. Since the contributions are made after tax, you will not pay taxes when you take disbursements.

When you compare a Roth 401(k) vs. a Roth IRA, you will notice that both have contributions made on an after-tax basis, and neither will subject you to taxes when you take distributions. However, a Roth 401(k) vs. a Roth IRA has higher annual contribution limits. The Roth 401(k) contribution limits are the same as the contribution limits of a traditional 401(k). Another difference is that a Roth 401(k) has required minimum distributions beginning at age 70 1/2 while a Roth 401(k) does not have any required minimum distributions.

401(k) vs SIMPLE IRA

A SIMPLE IRA is another type of employer-sponsored plan that employers might opt to open instead of a 401(k) plan. These types of accounts are easier for employers to set up and to administer and are used by smaller employers who do not want the high administration costs of a 401(k) plan. Both employees and employers are able to set aside money for retirement savings.

Contributions to the plan are made on a pre-tax basis, and your savings are able to grow tax-deferred until you withdraw the money at retirement. The contribution limits are $13,000 for people who are younger than age 50 with a catch-up contribution of $3,000 per year for people who are 50 or older. Withdrawals that are made before you reach age 59 1/2 are subject to a 10 percent penalty in addition to taxes. There is also a required minimum distribution beginning when you reach age 70 1/2.

401(k) vs SEP IRA

A Simplified Employee Pension IRA is also known as a SEP IRA. A SEP is a type of employer-sponsored plan that may be offered by very small employers or opened by sole proprietors that have no employees. People who qualify for SEPs include individuals, employers, sole proprietors, and freelancers.

Money that is contributed to a SEP is made on a pre-tax basis. Taxes are paid at the time of disbursement. Under the SEP IRA rules, employers are required to contribute the same percentage that they contribute to their own accounts to those of their employees. The SEP IRA rules set the maximum employer contribution at 25 percent of the employees’ annual income or $56,000, whichever amount is less.

Like 401(k) plans, a SEP has an early withdrawal penalty of 10 percent. There is also a required minimum distribution that begins when you reach age 70 1/2.

A SEP IRA has higher potential contribution limits than a traditional 401(k) or other types of IRAs. These accounts are best for people who are self-employed or who have very few employees because of the rule that you must contribute the same percentage to your employees’ accounts as you do to your own.

401k vs ira vs roth ira

Multiple account rules

Whether you are trying to decide between a 401(k) or a Roth IRA, a 401(k) vs. an IRA, or another permutation, it is possible for you to open multiple accounts. However, you need to pay attention to the maximum allowed annual contributions if you open multiple accounts.

For example, if you have both a traditional IRA and a Roth account, your aggregate contributions to the two accounts cannot exceed $6,000 per year if you are younger than 50 or $7,000 per year if you are older than 50. You can also contribute to a 401(k) or a Roth IRA, or you can contribute to both a 401(k) and a Roth IRA. In that case, you can contribute up to $19,000 to your 401(k) and $6,000 to your Roth IRA if you are under 50, and $25,000 and $7,000 if you are over 50, respectively.

The M1 Finance investment platform

The M1 Finance investment platform allows you to choose the type of accounts that can help you to best meet your needs. The platform offers a choice between individual, joint, retirement, and trust accounts.

After you choose the account that fits you the best, you can then fund it according to your risk tolerance. You are able to select your own investments and decide what percentage of your investment funds that you want to allocate to each investment that you choose.

You can set up an automatic transfer of money from your deposit account so that you can invest on a continuing basis without giving it too much thought. M1 Finance engages in automatic rebalancing so that your savings have the opportunity to grow.

M1 benefits

M1 Finance allows you to invest without being charged any management or commissions. This feature allows your money to grow by potentially thousands of additional dollars over the life of your account. M1 Finance also offers personalization, good accessibility, and cutting-edge technology.  M1 Finance offers the ability to save time and earn more money with its innovative approach. It has been recognized by leading business publications as a smart digital investment choice. You can sign up now via the investing link or call us at 888.714.6674 to learn more