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October 23, 2024

Navigating retirement: similarities and differences of 401(k)s and IRAs

401(k)s and Individual Retirement Accounts (IRAs) have been commonly and mistakenly used interchangeably in the world of retirement. Both offer valuable tax advantages and are designed to help you build a nest egg for the future, but they come with distinct features that can influence your savings strategy. Whether you’re just starting your retirement planning or looking to optimize your savings, understanding these two accounts can help you make informed decisions about your financial future. In this article, we’re going to break down the similarities and differences of 401(k)s and IRAs, covering everything from establishment and eligibility to contribution limits and investment options.

Similarities between 401(k)s and IRAs

Let’s start with the commonalities between 401(k)s and IRAs, as they are both retirement savings vehicles and powerful tools for retirement savings:

Tax advantages: Both 401(k)s and IRAs are tax-advantaged savings accounts offer certain tax benefits, such as tax deferrals, deductions, or exemptions. These benefits are designed to encourage saving for long-term goals, allowing you to grow your investments over time without paying taxes on gains until you withdraw the funds. 

Investment opportunities: Both types of savings accounts provide flexibility in investment options that come with different levels of risk and potential returns, letting you diversify your portfolio with stocks, bonds, mutual funds, and other assets. The range of investments they offer can be tailored to suit the investor’s risk tolerance, time horizon, and financial goals.

Post-tax and traditional contributions: 401(k)s and IRAs both allow for the investor or plan participant to save on post-tax or traditional basis. In most cases, contributions are made on a post-tax or Roth basis. With post-tax accounts, you contribute post-tax income, and both your contributions and any earnings grow tax-free. A traditional retirement account allows you to typically reduce your taxable income by the amount you contribute each year, invest those contributions with tax-deferred growth, and then pay taxes on the withdrawals when you retire.

Withdrawals in retirement: For both IRAs and 401(k)s, the minimum age for making qualified withdrawals without incurring a 10% early withdrawal penalty is 59 ½ years old. At this age, investors can begin accessing their retirement funds without being penalized, though they will still owe ordinary income taxes on distributions from traditional 401(k)s and IRAs, as these accounts are tax-deferred.

Required Minimum Distributions (RMDs): Both plans require individuals to begin taking RMDs starting at age 73, ensuring that funds are eventually withdrawn and subject to taxation.

Differences between 401(k)s and IRAs

There are many key differences between 401(k)s and IRAs.

Establishment and setup: 401(k)s are employer-sponsored defined contribution retirement plans. Qualified employer may create these plans to offer an incentive for employees to save for retirement. The employee may select a percentage of their base pay, a Roth or pre-tax deferral, and a mutual fund investment for their plan. Plan features may include automatic enrollment, employer matching, and Roth contributions.

An individual retirement account is opened solely by an individual without an employer. An individual who works for an employer may still establish an IRA and contribute to the account. The individual must have earned income to make qualifying contributions during the year. Establishment may be completed through a broker, bank, or other financial institution.

Eligibility: Eligibility to contribute to a company 401(k) may depend on several circumstances, like age, service requirements, and part-time status. However, as far as income eligibility, there are no limits to the amount of income an individual may have to contribute to a 401(k) plan.

Eligibility to contribute to an IRA--Roth or Traditional--may be limited to household income levels and tax filing status. Earned income typically includes W-2 pay, like wages and salary, but is not limited to self-employment income, tips, or other active participation in work-related activity. Non-earned income examples are interest, dividends, capital gains, rental income, social security benefits, unemployment benefits, and more.

Contribution Limits: In 2024, the Internal Revenue Service (IRS) has set the pre-tax or Roth contribution limit at $23,000. This is the limit for employee contributions. Individuals over the age of 50 may make catch-up contributions of $7,500, making the total employee contribution limit of $30,500.

In 2024, the IRS has set the contribution limits for IRAs, both Roth and Traditional, at $7,000. Those individuals over the age of 50 may make catch-up contributions of $1,000, totaling to $8,000.

Investment Options: Investment options are typically limited in a 401(k) plan, with mutual funds being the main type of security. 401(k) plans will have a plan advisor who helps the employer sponsoring the plan to select certain funds for the plan participants. These pre-selected funds may be diversified by offering equity (stock), fixed income (bond), and money market options. Within the equity funds, there may be options for large, mid, and small caps funds, as well as international equity and fixed income options.

IRAs typically have greater flexibility than 401(k) plans. Depending on the brokerage firm or custodian, the range of investment options include stocks, bonds, mutual funds, electronic funds transfers, certificates of deposit, and more.

How to decide which retirement plan is right for you

Deciding between a 401(k) and an IRA ultimately depends on your individual financial circumstances, employment status, income level, and retirement goals. If you have access to a 401(k) with employer matching, it may provide a greater opportunity to grow your savings through both your contributions and employer funds. On the other hand, an IRA offers more flexibility in investment choices and may be ideal if you prefer managing your own portfolio. Assessing your income, tax considerations, and retirement timeline can help you choose the plan—or combination of both—that best supports your long-term financial security.

How can Marsh McLennan Agency Help?

For more information on retirement plans and to gain a deeper understanding of your financial options, don't hesitate to reach out to your MMA Prosper Wise℠ Team. Our knowledgeable advisors can provide personalized guidance tailored to your financial goals, helping you navigate the complexities of retirement planning and identify the most suitable strategies for securing your future. MMA Prosper WiseSM provides tools, education, and personalized coaching to help you prepare for and manage your retirement plans. Learn more about our retirement tools and resources.

Securities and investment advisory services offered through MMA Securities LLC (MMA Securities), member FINRA / SIPC, and a federally registered investment advisor. Main Office: 1166 Avenue of the Americas, New York, NY 10036. Phone: (212) 345-5000. Variable insurance products distributed by MMA Securities LLC, CA OK 81142. Marsh & McLennan Insurance Agency LLC and MMA Securities LLC are affiliates owned by Marsh & McLennan Companies. Investment advisory services for MMA Prosper WiseSM are offered solely as a Registered Investment Adviser through MMA Securities. Certain of our investment adviser representatives are registered representatives of MMA Securities. A copy of our written disclosure statement discussing our advisory services and fees is available for your review upon request. Please consult a tax professional for specific tax inquiries and recommendations. MMARetirement.com

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