Choosing how to save for your retirement can be a difficult decision. There are lots of choices of plans available to you and it can be tough to keep these plans separate from one another.
Two of the main retirement savings options are a 401k and an Individual Retirement Account (IRA). Our guide looks at the main differences between these two retirement schemes and will help you choose the right plan for you.
Contributing to your plan
One of the main differences between a 401k plan and an IRA is the way in which you contribute to your plan.
With a 401k plan, your retirement savings are automatically deducted from your paycheck and placed directly into your savings account. However, with an IRA you declare the amount of money you want to pay into your plan by using your tax form 1040. The amount you decide on is then deducted from your taxable income.
While there may be a difference in the way you contribute, there is essentially no real difference in the way the money is deducted between both plans.
Who runs the account
There are also differences between who runs the two retirement accounts. With a 401k, your employer will almost always sponsor the account for you. However, in an IRA (as the ‘individual’ suggests), you have to open, fund and run the account yourself.
When you pay taxes
Another important difference between an IRA and a 401k plan relates to the way the schemes deal with pre tax dollars.
In a 401k, anything that you decide to contribute to your plan is deducted from your pay before you pay tax. This means that you pay no tax until you start withdrawing money from the plan.
Conversely, an IRA allows you more control as to when you pay your taxes. For example, a Roth IRA works in the opposite way to a 401k in that you pay tax on your contributions now but you don’t pay any tax when you start to withdraw the money.
Remembering the differences
The simplest way to remember the difference between a 401k plan and an IRA is to think about who controls the plan. A 401k plan is run by your employer as they start the plan, decide what investments you can access and manage the account on a day to day basis.
With an IRA, you make all the decisions as to what and where you invest.
Opening both a 401k and an IRA
A common question is ‘can I have both a 401k plan and an IRA?’
The answer is ‘yes’ – although it depends on your situation. If you qualify for both types of plan then it is worth taking advantage of this as it can offer ‘free money’.