Comparison of 401(k) and IRA accounts

Last updated

This is a comparison between 401(k), Roth 401(k), and Traditional Individual Retirement Account and Roth Individual Retirement Account accounts, four different types of retirement savings vehicles that are common in the United States.

Contents

Comparison

Tax Year 2024(Traditional) 401(k) [1] [2] [3] Roth 401(k) [1] [2] [3] Traditional IRA [1] [2] [3] Roth IRA [1] [2] [3]
Tax benefitCapital gains, dividends, and interest within account incur no tax liability.
Subjected taxesContributions are usually pre-tax; but can also be post-tax, if allowed by plan. Distributions are taxed as ordinary income (except any post-tax principal).Contributions are post-tax. Qualified distributions are not taxable.Contributions are deductible (subject to conditions). When deducted, contributions are pre-tax, otherwise, they are post-tax. Distributions are taxed as ordinary income (except any non-deducted principal).Contributions are post-tax. Qualified distributions are not taxable.
Employer or IndividualEmployer or sole proprietor sets up this plan.Individual sets up this plan.
Contribution LimitsEmployee contribution limit of $23,000/yr for under 50; $30,500/yr for age 50 or above in 2024; limits are a total of pre-tax Traditional 401(k) and Roth 401(k) contributions. [4] Total employee (including after-tax Traditional 401(k)) and employer combined contributions must be lesser of 100% of employee's salary or $69,000 ($76,500 for age 50 or above). [5] There is no income cap for this investment class.$7,000/yr for age 49 or below; $8,000/yr for age 50 or above in 2024; limits are total for traditional IRA and Roth IRA contributions combined. Cannot contribute more than annual earned income. For direct contributions to Roth IRAs, contribution limit is reduced in a "phase-out" range, for single MAGI > $146,000 and joint MAGI > $228,000 [6] (For this purpose, however, MAGI excludes any Roth conversions. [7] ) Contribution limit does not apply to conversions from traditional IRA (or qualified employer plans) to Roth IRA.
Contribution notesEffective limit is higher than traditional 401(k) as the contributions are post-tax.Effective limit is higher than traditional IRA as the contributions are post-tax.
Matching ContributionsMatching contributions available from some employers.Matching contributions available through some employers, but they must sit in a pretax account. [8] No matching contributions available.
Deduction LimitsGenerally no limit on the amount deductible from income, but somewhat complicated due to HCE (highly compensated employees) rules.Full deduction available on incomes up to $198,000, depending on tax filing status. See full rules.Tax-exempt earnings on contributions available up to incomes of $208,000, depending on tax filing status. See full rules and Backdoor Roth IRA Contributions.
(Traditional) 401(k) Roth 401(k) Traditional IRA Roth IRA
DistributionsDistributions can begin at age 59½ or if owner becomes disabled.Distributions can begin at age 59½ and the account has been open for at least 5 years, or if owner becomes disabled, with some exceptions.Distributions can begin at age 59½ or if owner becomes disabled.Distributions can begin at age 59½ as long as contributions are "seasoned" (5 years from January 1 of the year the first contribution was made) or owner becomes disabled.
Forced DistributionsMust start withdrawing funds at age 72 unless employee is still employed with employer setting up the 401(k), and not a 5% owner. Penalty is 50% of minimum distribution.Must start withdrawing funds at age 72. Penalty is 50% of minimum distribution.None.
LoansWhen still employed with employer setting up the 401(k), loans may be available depending upon the plan, not more than 50% of balance or $50,000.No
Early WithdrawalGenerally no when still employed with employer setting up the 401(k). Otherwise, 10% penalty plus taxes. There are some exceptions to this penalty. [9] Generally no when still employed with employer setting up the 401(k). Otherwise, taxes on the earnings, plus 10% penalty on taxable part of distribution and taxable part of unseasoned conversions. There are some exceptions to this penalty.10% penalty plus taxes for distributions before age 59½ with exceptions.Principal of contributions and seasoned conversions can be withdrawn at any time without tax or penalty. Additional amounts are subject to normal income taxes and 10% penalty if not qualified distributions.
Home Down PaymentPurchase of primary residence and avoidance of foreclosure or eviction of primary residence, subject to 10% penalty, if hardship withdrawals are available in the plan. [10] If your plan permits distributions from accounts because of hardship, you may choose to receive a hardship distribution from your designated Roth account. The hardship distribution will consist of a pro-rata share of earnings and basis and the earnings portion will be included in gross income unless you have had the designated Roth account for 5 years and are either disabled or over age 59 ½.Can withdraw up to $10,000 for a first time home purchase down payment with stipulations.Up to $10,000 can be used for primary home down payment. Must have held Roth IRA for a minimum of 5 years. Must not have owned a home in previous 24 months. House must be owned by IRA owner or direct linear ancestors or descendants.
Education ExpensesPayment of secondary educational expenses in last 12 months for employee, spouse, or dependents, subject to 10% penalty, if hardship withdrawals are available in the plan. [10] Can withdraw for qualified higher education expenses of owner, children, and grandchildren.
Medical ExpensesMedical expenses not covered by insurance for employee, spouse, or dependents, subject to 10% penalty, if hardship withdrawals are available in the plan. Medical expenses in excess of 7.5% of your adjusted gross income may be exempt to the 10% penalty. [10] Can withdraw for qualified unreimbursed medical expenses that are more than 7.5% of AGI; medical insurance during period of unemployment; during disability.
(Traditional) 401(k) Roth 401(k) Traditional IRA Roth IRA
Conversions and RolloversUpon termination of employment (or in some plans, even while in service), can be rolled to IRA or Roth IRA. When rolled to a Roth IRA, taxes need to be paid during the year of the conversion.Cannot be converted to a traditional 401(k), but upon termination of employment (or in some plans, even while in service), can be rolled into Roth IRA.Can be converted to a Roth IRA, typically for backdoor Roth IRA contributions. Taxes need to be paid during the year of the conversion. Also, the non-basis portion can be rolled over into a 401(k), if allowed by the 401(k) plan.
Changing InstitutionsCan roll over to another employer's 401(k) plan or to a rollover IRA at an independent institution.Can roll over to another employer's Roth 401(k) plan or to a Roth IRA at an independent institution.Funds can be either transferred to another institution or they can be sent to the owner of the traditional IRA who has 60 days to put the money in another institution in a rollover contribution to another traditional IRA. [11]
BeneficiariesFor married persons, federal law dictates that the beneficiary of any form of 401(k) automatically be the surviving spouse. A different party may be named beneficiary, however, provided the surviving-spouse-to-be has consented and the consent is in written form. For single persons, any party may be named beneficiary; however, if no beneficiary is named, then it defaults to the decedent's estate.When owner dies, spouse as beneficiary can roll both accounts into one IRA account. Other beneficiaries will be subject to forced distributions (taxable) over a ten-year period. Beneficiaries will not pay estate tax if the inheritance is under the exemption amount.
ProtectionAccount is protected from bankruptcy and creditors (with limited exceptions, e.g. IRS).Account is protected from bankruptcy up to $1,362,800. [12] Protection from creditors varies by state (from none to full protection).
(Traditional) 401(k) Roth 401(k) Traditional IRA Roth IRA


See also

Related Research Articles

In the United States, a 401(k) plan is an employer-sponsored, defined-contribution, personal pension (savings) account, as defined in subsection 401(k) of the U.S. Internal Revenue Code. Periodic employee contributions come directly out of their paychecks, and may be matched by the employer. This pre-tax option is what makes 401(k) plans attractive to employees, and many employers offer this option to their (full-time) workers. 401(k) payable is a general ledger account that contains the amount of 401(k) plan pension payments that an employer has an obligation to remit to a pension plan administrator. This account is classified as a payroll liability, since the amount owed should be paid within one year.

An individual retirement account (IRA) in the United States is a form of pension provided by many financial institutions that provides tax advantages for retirement savings. It is a trust that holds investment assets purchased with a taxpayer's earned income for the taxpayer's eventual benefit in old age. An individual retirement account is a type of individual retirement arrangement as described in IRS Publication 590, Individual Retirement Arrangements (IRAs). Other arrangements include employer-established benefit trusts and individual retirement annuities, by which a taxpayer purchases an annuity contract or an endowment contract from a life insurance company.

A Roth IRA is an individual retirement account (IRA) under United States law that is generally not taxed upon distribution, provided certain conditions are met. The principal difference between Roth IRAs and most other tax-advantaged retirement plans is that rather than granting a tax reduction for contributions to the retirement plan, qualified withdrawals from the Roth IRA plan are tax-free, and growth in the account is tax-free.

A 529 plan, also called a Qualified Tuition Program, is a tax-advantaged investment vehicle in the United States designed to encourage saving for the future higher education expenses of a designated beneficiary. In 2017, K–12 public, private, and religious school tuition were included as qualified expenses for 529 plans along with post-secondary education costs after passage of the Tax Cuts and Jobs Act.

<span class="mw-page-title-main">Economic Growth and Tax Relief Reconciliation Act of 2001</span> The "EGTRRA"

The Economic Growth and Tax Relief Reconciliation Act of 2001 was a major piece of tax legislation passed by the 107th United States Congress and signed by President George W. Bush. It is also known by its abbreviation EGTRRA, and is often referred to as one of the two "Bush tax cuts".

In the United States, a 403(b) plan is a U.S. tax-advantaged retirement savings plan available for public education organizations, some non-profit employers (only Internal Revenue Code 501(c)(3) organizations), cooperative hospital service organizations, and self-employed ministers in the United States. It has tax treatment similar to a 401(k) plan, especially after the Economic Growth and Tax Relief Reconciliation Act of 2001. Both plans also require that distributions start at age 72 (according to the rules updated in 2020), known as Required Minimum Distributions (RMDs). Distributions are typically taxed as ordinary income.

A health savings account (HSA) is a tax-advantaged medical savings account available to taxpayers in the United States who are enrolled in a high-deductible health plan (HDHP). The funds contributed to an account are not subject to federal income tax at the time of deposit. Unlike a flexible spending account (FSA), HSA funds roll over and accumulate year to year if they are not spent. HSAs are owned by the individual, which differentiates them from company-owned Health Reimbursement Arrangements (HRA) that are an alternate tax-deductible source of funds paired with either high-deductible health plans or standard health plans.

The 457 plan is a type of nonqualified, tax advantaged deferred-compensation retirement plan that is available for governmental and certain nongovernmental employers in the United States. The employer provides the plan and the employee defers compensation into it on a pretax or after-tax (Roth) basis. For the most part, the plan operates similarly to a 401(k) or 403(b) plan with which most people in the US are familiar. The key difference is that unlike with a 401(k) plan, it has no 10% penalty for withdrawal before the age of 55. These 457 plans can also allow independent contractors to participate in the plan, where 401(k) and 403(b) plans cannot.

<span class="mw-page-title-main">Retirement plans in the United States</span>

A retirement plan is a financial arrangement designed to replace employment income upon retirement. These plans may be set up by employers, insurance companies, trade unions, the government, or other institutions. Congress has expressed a desire to encourage responsible retirement planning by granting favorable tax treatment to a wide variety of plans. Federal tax aspects of retirement plans in the United States are based on provisions of the Internal Revenue Code and the plans are regulated by the Department of Labor under the provisions of the Employee Retirement Income Security Act (ERISA).

A Savings Incentive Match Plan for Employees Individual Retirement Account, commonly known by the abbreviation "SIMPLE IRA", is a type of tax-deferred employer-provided retirement plan in the United States that allows employees to set aside money and invest it to grow for retirement. Specifically, it is a type of Individual Retirement Account (IRA) that is set up as an employer-provided plan. It is an employer sponsored plan, like better-known plans such as the 401(k) and 403(b), but offers simpler and less costly administration rules, as it is subject to ERISA and its associated regulations. Like a 401(k) plan, the SIMPLE IRA can be funded with pre-tax salary contributions, but those contributions are still subject to Social Security, Medicare, and Federal Unemployment Tax Act taxes. Contribution limits for SIMPLE plans are lower than for most other types of employer-provided retirement plans as compared to conventional defined contribution plans like Section 402(g), 401(k), 401(a), and 403(b) plans.

A Simplified Employee Pension Individual Retirement Arrangement is a variation of the Individual Retirement Account used in the United States. SEP IRAs are adopted by business owners to provide retirement benefits for themselves and their employees. There are no significant administration costs for a self-employed person with no employees. If the self-employed person does have employees, all employees must receive the same benefits under a SEP plan. Since SEP-IRAs are a type of IRA, funds can be invested the same way as most other IRAs.

A traditional IRA is an individual retirement arrangement (IRA), established in the United States by the Employee Retirement Income Security Act of 1974 (ERISA). Normal IRAs also existed before ERISA.

The Roth 401(k) is a type of retirement savings plan. It was authorized by the United States Congress under the Internal Revenue Code, section 402A, and represents a unique combination of features of the Roth IRA and a traditional 401(k) plan. Since January 1, 2006, U.S. employers have been allowed to amend their 401(k) plan document to allow employees to elect Roth IRA type tax treatment for a portion or all of their retirement plan contributions. The same change in law allowed Roth IRA type contributions to 403(b) retirement plans. The Roth retirement plan provision was enacted as a provision of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA 2001).

<span class="mw-page-title-main">Keogh plan</span> Type of pension plan in the U.S

Keogh plans are a type of retirement plan for self-employed people and small businesses in the United States.

A self-directed individual retirement account is an individual retirement account (IRA) which allows alternative investments for retirement savings. Some examples of these alternative investments are real estate, private mortgages, private company stock, oil and gas limited partnerships, precious metals, digital assets, horses and livestock, and intellectual property. The increased investment options available in self-directed IRAs prompted the SEC to issue a public notice in 2011 due an increased risk of fraud in alternative assets.

Required minimum distributions (RMDs) are minimum amounts that U.S. tax law requires one to withdraw annually from traditional IRAs and employer-sponsored retirement plans. In the Internal Revenue Code itself, the precise term is "minimum required distribution". Retirement planners, tax practitioners, and publications of the Internal Revenue Service (IRS) often use the phrase "required minimum distribution".

Rollovers as business start-ups (ROBS) are arrangements in the United States in which current or prospective business owners use their 401(k), IRA or other retirement funds to pay for new business start-up costs, for business acquisition costs or to refinance an existing business. In 2008, the Internal Revenue Service set up the ROBS Compliance Project to monitor such arrangements.

In the United States, an employer matching program is an employer's potential payment to their 401(k) plan that depends on participating employees' contribution to the plan.

A Solo 401(k) (also known as a Self Employed 401(k) or Individual 401(k)) is a 401(k) qualified retirement plan for Americans that was designed specifically for employers with no full-time employees other than the business owner(s) and their spouse(s). The general 401(k) plan gives employees an incentive to save for retirement by allowing them to designate funds as 401(k) funds and thus not have to pay taxes on them until the employee reaches retirement age. In this plan, both the employee and his/her employer may make contributions to the plan. The Solo 401(k) is unique because it only covers the business owner(s) and their spouse(s), thus, not subjecting the 401(k) plan to the complex ERISA (Employee Retirement Income Security Act of 1974) rules, which sets minimum standards for employer pension plans with non-owner employees. Self-employed workers who qualify for the Solo 401(k) can receive the same tax benefits as in a general 401(k) plan, but without the employer being subject to the complexities of ERISA.

<span class="mw-page-title-main">Form 1099-R</span> US tax form for reporting on income distributions

In the United States, Form 1099-R is a variant of Form 1099 used for reporting on distributions from pensions, annuities, retirement or profit sharing plans, IRAs, charitable gift annuities and Insurance Contracts. Form 1099-R is filed for each person who has received a distribution of $10 or more from any of the above.

References

  1. 1 2 3 4 "Publication 4530: Designated Roth Accounts Under a 401(k) or 403(b) Plan" (PDF). Internal Revenue Service. August 2009. Archived (PDF) from the original on 2017-09-30. Retrieved 2017-08-10.
  2. 1 2 3 4 "Designated Roth Accounts in 401(k) or 403(b) Plans". Internal Revenue Service. October 16, 2009. Archived from the original on June 22, 2012. Retrieved August 10, 2017.
  3. 1 2 3 4 "Comparison of Roth 401(k), Roth IRA, and Traditional 401(k) Retirement Accounts" (PDF). Internal Revenue Service. Archived (PDF) from the original on 2010-05-31. Retrieved 2017-08-10.
  4. ↑ "401(k) limit increases to $23,000 for 2024, IRA limit rises to $6,500".
  5. ↑ "Retirement topics: 401(k) and profit-sharing plan contribution limits | Internal Revenue Service".
  6. ↑ "401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000".
  7. ↑ "Publication 17 – Your Federal Income Tax (For Individuals) – Roth IRAs". taxmap.irs.gov. Retrieved 2020-08-30.
  8. ↑ "Retirement Plans FAQs on Designated Roth Accounts". Archived from the original on 2012-08-10. Retrieved 2017-08-10.
  9. ↑ "Topic 424 – 401(k) Plans". IRS.gov Tax Topics. February 5, 2011. Archived from the original on July 3, 2017. Retrieved August 10, 2017.
  10. 1 2 3 "Publication 575 (2010), Pension and Annuity Income". IRS.gov Tax Topics. February 5, 2011. Archived from the original on May 2, 2017. Retrieved August 10, 2017.
  11. ↑ "Publication 590: Individual Retirement Arrangements (IRAs)" (PDF). Internal Revenue Service. January 7, 2010. Archived (PDF) from the original on January 5, 2010. Retrieved August 10, 2017.
  12. ↑ Sheedy, Rachel (September 3, 2019). "Protecting Retirement Accounts from Creditors". Kiplinger. Archived from the original on January 27, 2021. Retrieved February 21, 2021.
This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.