Written by Douglas Velnoskey
What’s the difference between an IRA and a 401k? Does one have a benefit over the other? Individual Retirement Accounts (IRAs) and 401(k)s are plans for individuals to save for retirement. Many individuals participate in both.
IRAs offer specific personal income tax benefits. 401(k)s are employer sponsored. The biggest advantage of a 401(k) is the opportunity for a participant to make a significantly larger annual contribution versus an IRA. IRAs come in two types: Traditional (deductible or non-deductible) and Roth.
For the 2023 tax year, individuals with earned income are allowed to make a $6,500 tax deductible or non-deductible contribution to a traditional IRA. Individuals 50 years or older can contribute $7,500. Contributions are subject to tax filing status and income phase outs. Income limits apply to traditional deductible IRAs only if you or your spouse has a retirement plan at work. If neither you nor your spouse has a retirement plan at work, your contributions (up to the annual maximum) are fully deductible for the year they are made up to that year’s tax filing deadline.
Things to remember about IRAs:
- Investments within the account grow tax deferred.
- Withdrawals in retirement are taxed as ordinary income.
- Distributions are required at age 73 for individuals born before January 1, 1960, at age 75 for those born on or after that date.
- Unqualified withdrawals before age 59 ½ may trigger a 10% early withdrawal penalty and income taxes.
Roth IRAs have the same contribution limits as traditional IRAs but different income eligibility limits for contributions. Contributions are not tax deductible, distributions after age 59 ½ are not subject to income tax, and there are no requirements to take withdrawals at any age. Contributions may be withdrawn without being subject to income tax or penalties.
401(k) salary deferral limits for 2023 are $22,500 for employees under 50 years of age and $30,000 for those 50 and over. Most plans allow for traditional, pre-tax and Roth after-tax salary contributions. The participant owns participant contributions. Plan sponsors may make matching and/or profit-sharing employer contributions to participant’s 401(k) accounts. Typically, the employer contributions are “vested” meaning ownership of those contributions transfers to the participant over time. 401(k) plans have varying rules about distributions and loans from participant accounts. Withdrawals from 401(k)s prior to age 59 ½ are typically taxed and a 10% penalty tax is imposed unless certain criteria are met.
The appropriate combination of IRA, Roth IRA and 401(k) contributions is an important part of everyone’s retirement planning.
The concepts illustrated here have legal, accounting and tax implications. Neither Janney Montgomery Scott LLC nor its Financial Advisors give tax, legal, or accounting advice. Please consult with the appropriate professional for advice concerning your particular circumstances. For more information about Janney, please see Janney’s Relationship Summary (Form CRS) on www.janney.com/crs which details all material facts about the scope and terms of our relationship with you and any potential conflicts of interest.
