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401(k) vs IRA: Basic Differences

Humans share 90% of their DNA with mice, cattle, dogs and elephants. Similarly, 401(k) accounts and IRAs (Individual Retirement Accounts) are about 90% similar. But as with humans versus cows, the 10% difference could be pretty significant.

The 401(k) Account:
– The amount that you are able to contribute each year is currently $20,500 ($27,000 if you are 50 or older.)
– You can take a loan from a 401(k).
– Withdrawals before the age of 59 ½ are usually allowed for “hardships”, a somewhat nebulous term defined by your employer’s 401(k) plan administrator. (There will still often be a 10% penalty, however.)
– The “Rule of 55” applies. This means that you can make penalty-free withdrawals from the 401(k) account of your last employer if you are at least 55 years old and leave that job.
– Your employer may match your 401(k) contributions.
– Money in a 401(k) account is usually fully protected if you file bankruptcy.
– If you continue to work after the age of 72 at the company where your 401(k) is held, you will not be required to take Required Minimum Distributions (RMD).
– For most people, the income limit for contributing to a 401(k) is not a factor.

The IRA Account:
– The amount that you are able to contribute each year is currently $6,000 ($7,000 if you are 50 or older).
– You cannot take a loan from an IRA.
– The “Rule of 55” does not apply.
– Similar to a 401(k), except for very specific hardships (such as large medical costs, disability), penalty-free withdrawals usually cannot happen until you are 59 ½ years old. However, there are limited exceptions to the 10% penalty for qualified education expenses, first time home purchases and birth or adoption of a child. (Income tax may still apply depending on the purpose.)
– Money in an IRA is protected in bankruptcy, but only up to about $1,362,800. (The number is inflation-adjusted annually.)
– Sometimes there are more low fee investment choices with an IRA than a 401(k).
– You can contribute to an IRA either regularly or intermittently, as you prefer.
– Your ability to contribute to a Roth IRA, or take a tax deduction for contributions to a traditional IRA, is limited by your income.

What about the Roth 401(k) versus Roth IRA? Much of the above applies, with an extra twist:
While there are no RMDs with Roth IRA accounts, the RMD rule does apply to the Roth 401(k).

For many, having a foot in both camps is the right choice, either to save more overall to fund retirement or to take advantage of specific provisions that are unique to a particular type of retirement account. As always though, the most important decision is to save enough for retirement, regardless of which vehicle you choose.