401(k) vs IRA: What Are the Differences?

Jenius Bank Team4/19/2024

Woman sitting at a kitchen table with a thoughtful expression. Illustrated dollar bills are floating behind her.

Both 401(k)s and IRAs may help you save for retirement, but they work differently. It’s never too soon to start saving for retirement, but one of the best ways to help build your retirement savings is to open a dedicated retirement account. Opening a 401(k) or an Individual Retirement Account (IRA) puts your money to work for the future.¹Though both 401(k)s and IRAs help you save for retirement, they work in different ways. We’ll look at how these accounts differ and what you should think about before you open your retirement savings account.This information is not tax or investment advice. You should consult with a tax advisor and/or a qualified investment professional for advice specific to your particular circumstances.

Key Takeaways

Both IRAs and 401(k)s are retirement savings accounts that invest your money into different funds to build your savings.
401(k)s are managed through employers while IRAs are available to individuals through financial institutions.
Many people benefit from opening both accounts to help maximize their retirement savings.

IRAs and 401(k)s – An Overview

Both 401(k) accounts and IRAs are designed to help you save for retirement, but that’s really where their similarities end. Let’s take a quick look at how each account works.

What Is a 401(k)?

A 401(k) is a type of tax-deferred retirement account that’s sponsored by your employer. You’re able to contribute to the account by setting up recurring contributions from your paycheck. Some industries offer similar accounts that are called 403(b) or 457 plans.These retirement accounts allow participants to make contributions from their paycheck, often on a pre-tax basis. Pre-tax contributions are excluded from your gross pay, which reduces your taxable income in the near term. You owe income taxes on the funds and their earnings when you withdraw them.²Many employers offer to match your 401(k) contributions up to a certain percentage of your salary as part of your total compensation. If your employer offers a match, be sure to understand their vesting policy. Vesting refers to how much of your employer’s contributions you “own” and if you leave the company before you’re fully vested, you may forfeit some, or all, of your employer’s contributions.³The IRS limits how much you may contribute to a 401(k) account each year. In 2024, individuals under 50 may contribute up to $23,000 and those 50 and over can contribute an additional $7,500.⁴

What Is an IRA?

An IRA is another type of tax-deferred account designed to help you build your retirement savings. Unlike 401(k)s, IRAs aren’t sponsored by your employer. Instead, you open and manage these accounts on your own. Since IRAs aren’t dependent on your employer, you could open one as soon as you have earned income. There aren’t any minimum age requirements for IRAs. Opening one early and contributing a small amount could make a significant difference in the future. For traditional IRAs, you contribute funds from your bank account. Then you receive a 5498 form at the end of the year stating how much you contributed to the account and what may be deducted from your gross income when filing your tax returns.⁵Just like 401(k)s, IRAs have contribution limits in place. In 2024, you’re able to contribute up to $7,000 if you’re under age 50 and up to $8,000 if you’re 50 and over.⁶

Roth 401(k)s and IRAs

So far, the IRAs and 401(k)s we’ve mentioned were considered “traditional”. But IRAs and 401(k)s actually also come in a Roth form. For both 401(k)s and IRAs, the primary difference between traditional and Roth accounts is the same; traditional accounts are funded with pre-tax dollars and Roth accounts are funded with post-tax dollars.Check with your benefits manager to learn how to allocate post-tax dollars to a Roth 401(k). These deductions are typically taken from your check alongside tax withholdings and other payroll deductions. To fund a Roth IRA, you may contribute funds directly from your bank account.⁷One difference to keep in mind between Roth 401(k)s and Roth IRAs is the income restrictions on Roth IRAs. Taxpayers who make over a certain amount aren’t eligible to contribute to a Roth IRA.⁸Check in with your tax advisor for help evaluating if a Roth IRA may work for you.

Required Minimum Distributions

Required Minimum Distributions (RMDs) are minimum amounts that people must withdraw from certain tax-deferred retirement accounts once they reach age 73.⁹ These distributions are taxed as regular income, and a penalty is levied if you don’t withdraw the required amount.¹⁰Traditional 401(k)s and IRAs have RMDs starting at 73 years old.¹¹ Roth IRAs don’t have RMDs unless the account owner passes away.¹²Roth 401(k)s were subject to RMD rules in 2022 and 2023, however beginning in 2024, they no longer have RMDs.¹³

What Are the Differences Between IRAs and 401(k)s?

Let’s look at a side-by-side comparison of traditional IRAs and traditional 401(k)s and how they could help you save for retirement.¹⁴

	IRAs	401(k)s
Who Can Participate	Anyone with earned income;	Eligible employees with access to an employer-sponsored plan
Contribution Details	Funded with tax deductible contributions	Pre-tax contributions withdrawn directly from your paycheck
Contribution Limits¹⁵	$7,000 in 2024 for individuals under 50; $8,000 for those 50 and older	$23,000 in 2023 for individuals under 50; $30,500 for those 50 and older
Employer Matching	N/A	Your employer may match some of your contributions
Vesting	N/A	May require a vesting period before employer contributions are yours
Investment Options	Investment options depend on where you open your account	Require you to choose among the options your employer selects
Age to Withdraw Without Penalty	59 ½ years old	59 ½ years old
Required Distribution Age for Traditional Accounts	73 years old	73 years old
Loans	Loans against IRAs are not allowed	Plan may allow you to borrow up to 50% of your account’s vested value or a maximum of $50,000¹⁶
Early Withdrawal Penalties	10% penalty on withdrawals before age 59 ½ (unless an exception applies)	10% penalty on withdrawals before age 59 ½ (unless an exception applies) Some plans don’t allow early withdrawals

What Are the Differences Between Roth IRAs and Roth 401(k)s?

Let’s also look at a side-by-side comparison of Roth IRAs and Roth 401(k)s and how they could help you save for retirement.¹⁷

	Roth IRAs	Roth 401(k)s
Who Can Participate	Anyone with earned income who meets income requirements	Eligible employees with access to an employer-sponsored plan
Contribution Details	Funded with after-tax dollars	After tax contributions withdrawn directly from your paycheck
Contribution Limits¹⁸	$7,000 in 2024 for individuals under 50; $8,000 for those 50 and older	$23,000 in 2023 for individuals under 50; $30,500 for those 50 and older
Employer Matching	N/A	Your employer may match some of your contributions. Check with your benefits manager to understand how matched contributions will be allocated and taxed.¹⁹
Vesting	N/A	May require a vesting period before employer contributions are yours
Investment Options	More diverse investment options available	Restricted to what their employer selects
Age to Withdraw Without Penalty	59 ½ years old	59 ½ years old
Required Distribution Age	No required minimum distributions	No required minimum distributions beginning 2024²⁰
Loans	Loans against IRAs are not allowed	Plan may allow you to borrow up to 50% of your account’s vested value or a maximum of $50,000²¹
Early Withdrawal Penalties	10% penalty on withdrawals before age 59 ½ (unless an exception applies) Earnings subject to taxes if withdrawn before the account is 5 years old	10% penalty on withdrawals before age 59 ½ (unless an exception applies) Earnings subject to taxes if withdrawn before the account is 5 years oldSome plans don’t allow early withdrawals

Which Retirement Plan May Be Right for You?

Ultimately, opening any account to help you save for retirement could be a smart financial move. Opening a 401(k) is a particularly good idea if your employer matches your contributions. Otherwise, you’d lose out on that benefit. But a 401(k) alone may not be enough to help you fully prepare for retirement. By opening either a traditional or Roth IRA, you may be able to save even more each year and possibly set yourself up for a more comfortable retirement.Remember, both 401(k)s and IRAs are investment accounts, so there is some risk involved. Consult with an investment or retirement advisor about the appropriate risk level for your retirement savings.

Final Thoughts

Opening a retirement account could help you build savings for your golden years. If your employer offers a 401(k) account, you may want to sign up as soon as you're eligible. But if they don’t or you want to further maximize your savings potential, you may want to consider an IRA. No matter what option you choose, be consistent and contribute to the account regularly. The more you save now, the more you may have on hand when you’re ready to retire. If you’re looking for additional ways to save, a high-yield savings account may be for you. Learn more about Jenius Savings today.

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