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Differences Between IRAs, Roth IRAs, and 401(k) Plans

Planning for retirement is a good goal for everyone.

For those under forty, the idea of retirement is still nebulous and distant. But for people who are over forty, retirement looms closer each year. There are various account types for retirement savings designed to put an objective in place for retirement planning, but reviewing all the options, it can seem like an alphabet soup of choices.

Here we’ll look at the differences between the three most popular retirement savings plans: IRA, Roth IRA, and 401(k).


Individual Retirement Accounts (IRA) are designed to encourage you to save for retirement. This type of long-term savings account has certain tax advantages as well as some limitations. Some things to remember about IRAs include:

● Anyone with earned income can open one. IRAs have a specific definition of income and it does not include money made from interest, dividends, Social Security, or child support. They may be nondeductible if income is too high.

● They can be opened through a bank, investment company, brokerage firm, or credit union.

● Because it is designed as long-term savings, money cannot be withdrawn before you are 59 ½ years old. There is an early withdrawal federal penalty of 10% if you do so. There may also be a state penalty.

● There are four types of IRA plans: Traditional, Roth, SEP (self-employed individual), and SIMPLE (savings incentive match plan for employees).

One of the most common IRAs is the Traditional IRA and here are some of the hallmarks of the Traditional IRA: Your contributions are tax deductible. This means that your taxable annual income decreases by the amount you have contributed to your IRA that year. For example, if you contributed $5,000 into your IRA, your taxable income would decrease by $5,000 that year. This may change if you participate in an employer plan like 401(k) depending on your adjusted gross income.

  1. You pay tax when you withdraw the money in retirement. Your money will grow, without having to pay tax, until you start to withdraw it. Once you start to withdraw from the account, you will pay tax on it at your ordinary income tax rate. Required minimum distributions must begin at age 72 to the account owner.

  2. Contributions have a yearly cap. Currently, the annual individual contribution to an IRA cannot be more than $6000 per year. If you are over 50 years old, you may contribute up to $7000 per year.

Roth IRAs

Roth IRAs, while similar to a Traditional IRA, have some distinct differences in terms of tax deductions, eligibility, and distribution of funds. These differences include:

  1. Your contributions are not tax deductible. You are funding this retirement account with after-tax money, so it is not tax deductible.

  2. Your withdrawals in retirement are tax-free. Because you already paid the tax on the contribution, you do not have to pay tax on it when you receive disbursements.

  3. Your current income determines whether you can participate. If you are an individual who makes more than $129,000 annually or a married couple filing jointly making more than $204,000, you do not qualify for a Roth IRA.

  4. Withdrawals can be made anytime or not at all. Contributions can be withdrawn, tax-free and penalty-free at any time, given certain parameters. Earnings are taxed if you pull the money out prior to age 59 1/2. There is also a five-year rule from when you first made a contribution to a Roth IRA. Unlike Traditional IRAs, there is no required distribution starting at age 72.


Another type of retirement savings plan is the 401(k). It is an employer-sponsored plan that has some similarities to an IRA, but also some notable differences. If your employer offers a 401(k), you can expect it to work like this:

● Your contributions are taken directly out of your paycheck.

● Contributions are tax-deductible. Roth 401(k) is not tax-deductible.

● You can contribute up to $20,500 annually. People over 50 years old can contribute $27,000 annually.

● Many employers contribute to 401(k) plans, such as 50% on the first 3% that an employee contributes. This employer match can help your savings grow even faster.

● They offer protection from creditors and federal tax liens. Because a 401(k) plan legally belongs to your employer rather than you, they are normally protected from your creditors who do not have access to them.

For a Traditional 401(k) plan, there are some important things to keep in mind, including:

  1. There is a 10% early withdrawal penalty if you take money out before you are 59 ½ years old.

  2. You can take out a loan on your 401(k) and pay yourself back over time.

  3. The required minimum distribution starts at age 72. Consult the SECURE Act guidelines to determine the correct year your RMD should start.

  4. Contributions can continue to be made after age 72 or as long as you are still working.

  5. For a Roth 401(k) plan, you pay tax before your contribution so your withdrawals are tax-free.

Which One is Right for Me?

The best retirement plan for you depends on several factors including your income tax bracket, future Social Security benefits, and how much you will need for retirement. Something to think about is what you think your income will be once you retire as compared to what it is now. Questions to keep in mind include:

● How much money do I need to live on during retirement?

● Do I plan on staying in or selling my home?

● When will I begin taking Social Security?

● How will I pay for medical expenses?

● What will my income tax bracket be during retirement?

There are many factors that play into your decision regarding which retirement plan, or a combination of plans, to choose. A financial advisor can help you map out what you hope to achieve with a retirement plan and come up with the best combination of plans to reach your goal.

In Summary

For most people, their pension and/or Social Security payments may not be enough income to fund their retirement years. Having a retirement savings account in place is a crucial step in planning for the future. Talking to a financial planner can help you take the next step.

Written by Matthew Delaney


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