The Difference Between a 401K & an IRA

Saving for your retirement should be a priority, even if you can sock away only a small amount. The most common forms of retirements savings accounts are the 401(k) and an Individual Retirement Account, or IRA. You can invest in both types, but it's important to understand the differences between accounts.

Tax Benefits

Retirement accounts offer tax advantages over other types of investment plans. If you're investing in a 401(k) or a traditional IRA, you don't have to pay taxes on the money until you withdraw it. A high contribution may keep you in a lower tax bracket. On the other hand, the money that you contribute to a Roth IRA has already been taxed, so you do not have to pay taxes on it when you retire and start making withdrawals.

Maximum Contributions

There are limits to the amount of money that you can contribute to each type of account. These limits vary by year, but the limit for a 401(k) is usually higher than the limit for an IRA.

Borrowing Money

A 401(k) allows you to borrow money from your account. This works like a traditional loan in that you'll have to pay interest when you pay back the loan--but you're paying that interest back to yourself. You cannot borrow money from your IRA.

Investment Choices

Your 401(k) goes through your a financial company that your employer has chosen. There are typically a limited number of investments you can choose from. Typically, these are based on your financial goals and the amount of risk you want to take. With an IRA, you have more flexibility in what you invest in with the ability to choose from any stock or mutual fund the company offers.

Employer Contributions

When you're making contributions to your IRA, you're on your own. However, with a 401(k), your employer often makes a matching contribution. There are limits to this "free money"--it's usually only up to a certain percentage of your salary, and you have to work for the company for a number of years before the money really becomes yours.

About the Author

Maggie McCormick is a freelance writer. She lived in Japan for three years teaching preschool to young children and currently lives in Honolulu with her family. She received a B.A. in women's studies from Wellesley College.