The finance and retirement plan industries are riddled with complicated terminology and fine print that are sometimes impossible to decipher. As a result, picking the right retirement plan can be extremely difficult.
This guide will easily differentiate between two of the most common retirement planning vehicles on the market: a 401(k) Plan and Individual Retirement Account (IRA).
A 401(k) Plan allows eligible employees to make salary deferral (reduction) contributions either before or after taxes. Employers that offer a 401(k) plan may make matching contributions to the plan on behalf of eligible employees, and may also add a profit-sharing feature to the plan. Earnings in a 401(k) plan accrue on a tax-deferred or tax-exempt basis.
401(k) Plans are widely popular, with more than half a million different company plans in place with over 50 million employees actively participating in a 401(k) plan.
In contrast to a 401(k) Plan, an IRA is an account that any individual may establish to arrange and plan for retirement. Generally, an IRA plan allows you to save money and defer taxes until you retire.
There are a variety of IRAs to choose from, including:
• Traditional IRAs
• Roth IRAs
• SIMPLE/SEP IRAs
Picking Between the Two
There are several differences and similarities that make each retirement planning vehicle an attractive option for saving for retirement. Picking the right plan is the challenge.
For example, anyone under the age of 70½ who earns an income can participate in an IRA, whereas in the case of 401(k) plans, you must work for an employer who provides a 401(k) plan to have an account.
401(k) plans are generally preferred by business owners looking to reduce their company’s taxable revenue and income.
Both plans, along with 403(b) plans, can be rolled into other types of plans. In addition, these plans have annual contribution limits, established by the government, that tend to rise gradually with inflation.
Finally, a 401(k) Plan will generally be selected by a business owner, for the increased tax sheltering opportunities this type of plan provides, primarily through much larger contributions than an IRA allows.