What’s the Difference Between a 401k and an IRA?

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You may be considering opening a 401k or an IRA, but perhaps you’re unsure as to what they entail.

What’s the difference between a 401k and an IRA, exactly? Keep reading for all you need to know!

What Is a 401k?

Essentially, a 401k is a qualified retirement plan that’s sponsored by your employer. If your employer offers one, it often makes sense to go for a 401k instead of an IRA, but that won’t be the case for everybody.

A lot of employers will offer a matching contribution up to a given percentage of your salary. They might match your contribution up to 8%, for example, in which case it makes sense for you to contribute at least 8% too. If not, you’re essentially saying no to free money!

Meanwhile, anything that you contribute to your 401k is counted as pretax money. Hence, you won’t be taxed on it during the year in which you earned it.

Only when you withdraw the money during retirement will you pay taxes.

What Is an IRA?

Almost anybody can contribute to an IRA, or individual retirement account, for retirement planning — no matter your employer.

When it comes to contributing to your IRA, the annual limit for 2021 is $6,000, but $7,000 for over 50s — when setting up and funding your IRA, you have until the day your taxes are due.

There are two main types of IRA — Roth IRAs and traditional IRAs. We’ll go into them below, as they both have a few differences to be aware of.

Roth IRA vs Traditional IRA

A traditional IRA is similar to a 401k in that any money you contribute is pretax money — you won’t be taxed on it until it’s withdrawn during retirement.

Moreover, traditional IRAs can offer contributions that are tax-deductible, for those who aren’t in a plan sponsored by their employer.

However, a Roth IRA offers different tax advantages to a traditional IRA.

You’ll pay tax on income before you contribute it to your IRA, but then you won’t pay anything in retirement.

What you need to be aware of, however, is that not everybody qualifies for a Roth IRA. To qualify in 2021, you’ll need a modified adjusted gross income of under $140,000, or $208,000 if you’re a married couple filing together.

What’s the Difference Between a 401k and an IRA? 

So, what’s the difference between a 401k and an IRA? Now you should know! Let’s face it — if you’re eligible for a 401k, it’s almost definitely the best option for you.

It makes the process of saving for retirement a whole lot easier, and as money is taken out of your paycheck each month automatically, there’s less to worry about!

If you’re not eligible for one, you should definitely consider opening an IRA, however. We’re leaning more toward the Roth IPA, however, as it has fewer restrictions once you’re retired and there’s more flexibility with early withdrawal rules too.

There’s no one-size-fits-all solution, so it’s best to sit down and carefully weigh up your options!

If you’re after more financial advice, don’t forget to check out the rest of your blog — we’re sure to have what you’re looking for.