401Ks And IRAs: What’s The Difference?
Traditional 401k and IRA are some of the most commonly used retirement plans for people who are looking to invest their funds long-term for the future. Both accounts offer the benefit of sheltering your savings from tax deductions until you start withdrawing funds from them, which will then be taxed according to your normal income tax rate.
However, there are many differences between a 401k and an IRA. While 401k accounts are set up by your employers, IRAs are individual retirement accounts. Fund contributions to a 401k are made on pre-tax basis while those to IRA accounts are made on post-tax income basis.
Here are a few more differences between the two so that you can opt for the one best suited to your needs.
Deduction on Contributions
One good thing about traditional IRAs is that any person with earned income can make their contribution to the account, but not everyone can deduct contributions from their taxable income. Whereas, people who are active participants of an official 401k are able to make pre-tax contributions, regardless of what their income is. This lowers their taxable income.
The Limits of Contribution
The government imposes annual contribution limits to tax-favored savings accounts. This restricts the amount of money you can save away. 401ks are more at an advantage here as those under 50 can contribute up to $18,000 while those aged above 50 can contribute up to $6000, totaling it to $24,000. On the other hand, only contributions of $5,500 per year can be made to traditional IRAs for those who are aged less than 50; while those above 50 can contribute to $6,500 per year.
The Form of Investments
401ks can hold investments of stocks, bonds, dividends, Capital gains, Mutual Funds, and interest without incurring tax liability. IRAs can also hold stocks, bonds, real estate (in particular IRAs), mutual funds, capital gains, dividends, and interest in the account without incurring any tax liabilities.
The Tax Implications
Money that is deposited in 401k accounts will be tax-deferred and will continue to grow tax-free in the account. The gains made in the account will also not be taxed. Any distributions made from the account will be taken as ordinary income and will be subject to taxation accordingly. In IRAs, the contributions may be considered tax-deductible as subject to any income limits. The gains amassed in the account will not be taxed and any distributions will be considered as ordinary income and will be taxed accordingly.