IRAs and 401(k)s are two popular types of retirement savings accounts. Most people who work in the private sector have at least one of these accounts (government employees often have different options), and many people own several retirement accounts.
Although they both serve the same purpose, the accounts have some important distinctions:
|How do you open an account?||Open an account with a financial institution and deposit some money.||Your employer must sponsor an account, and you sign up through HR.|
|How do you contribute?||Transfer money to your account.||Set up automatic payroll deductions.|
|How much can you contribute?||$6,500 per year (though this amount changes year to year).||$22,500 per year (though this amount changes year to year).|
|When can you use the money?||Not until age 59½ (other than a few exceptions, such as for financial hardship).||Not until age 59½ (other than a few exceptions, such as for financial hardship).|
|Perks||Lots of choices for investment options.
Easy to consolidate accounts or move them to a new financial institution.
Many employers match your contributions up to a certain amount.
Both types of accounts can provide great perks, including:
One downside? Because the accounts are truly supposed to be used only for retirement, you can face a big tax and penalty bill if you ever need to withdraw money early. So it’s important not to treat them like savings accounts.
Both 401(k)s and IRAs come in two flavors: traditional and Roth. The main difference is when you pay taxes.
Because of this, Roth accounts are often a good fit for someone who has relatively low income today but expects to have higher income in retirement (like those early on in their careers).
If you’re choosing between accounts or just want to know what you’re in for, here are some things to keep in mind:
IRAs and 401(k)s are two types of retirement savings accounts. You can set up an IRA on your own, but a 401(k) needs to come through your employer. Other differences include how much you can contribute and investment options. Both types of accounts have tax advantages and the potential to grow and build your wealth for retirement.