What’s The Difference Between 401k and IRA?

The difference between 401k and IRA can be confusing. Here’s some clarification:

This section discusses 5 key concepts you need to know.

(Learn how to roll over 401k to IRA)

1. Employer sponsored vs. individual

In almost every circumstance, your 401k is sponsored by your employer. That just means that the company you work for is providing the opportunity for you. It doesn’t matter whether or not your employer actually makes contributions on your behalf.

(A lot of times, the company will match whatever you put into your 401k up to a certain percentage. If they do that, and you’re not contributing enough to maximize the benefit, you’re leaving money on the table, friend.)

IRAs, on the other hand, by definition are individual (that’s what the ‘I’ is for in IRA). This means that you open it, you fund it, and you are in charge of the investments. The buck stops with you.

2. Tax treatment

Another difference between 401k and IRA is that your 401k is usually funded with pre-tax dollars.

  • Whatever you put into your 401k is subtracted from your pay before you pay taxes.
    • The effect is that you pay less in taxes.
      • But you don’t dodge these taxes forever.
        • When you pull your savings out, the taxes that you dodged before come due.

When you open an IRA, you get more control over when you pay the taxes. Traditional IRAs work much like your 401k with regard to taxes. You get a nice break in the present moment, but the you pay the Piper down the road. Roth IRAs are the opposite. You pay the Piper now, and you get away scott-free when you withdraw.

3. Control

An easy way to summarize the difference between 401k and IRA is to look at the control aspect. Who’s the boss? Where does the buck stop?

In your 401k, your employer is the boss. They initiate the plan, they determine what investments you have access to, and they maintain all the records involved. Your IRA is exactly the opposite. Your employer is not involved whatsoever.

4. What happens if I leave my current employer?

When you leave an employer, you usually have a few options:

  1. You may be able to simply leave your assets in the old employer’s plan
  2. You may be able to transfer the balance to your new employer (if applicable)
  3. You can get a check for the whole amount, and pay taxes and a penalty
  4. You can roll it over to an IRA (this is usually the best choice)

5. Can I have both?

Absolutely. Most people can max out their 401k or other pre-tax employer sponsor plan and also have their own IRA. There are certain cases where you can’t. See a detailed answer to the age-old question… Can I contribute to a 401k AND an IRA?

If you’re able to do that, you absolutely should. Just ask yourself, “Do I like free money?” If the answer’s yes (which it probably is), then you’ll want to participate in as many tax-advantaged programs as possible. If the answer’s no, then, you’re weird : )

Learn how to Roll Over 401k to IRA

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