Is an IRA the Same as a 401K?

401k plans and individual retirement accounts both offer tax-preferred savings for retirement, and have similar rules concerning contributions and withdrawals. The two plans differ in several ways, however, the largest being that a 410k plan is sponsored by an employer for employees, while an IRA is set up by individuals.

Plan Basics

In their traditional forms, 401k plans and IRAs allow savers to deposit money and defer paying taxes on those contributions and their earnings until the money is withdrawn after age 59 1/2. 401k plans are set up by an employer on behalf of employees. Employees can defer part of their pay, pretax, and employers can contribute to the plan as well. IRAs are set up by individuals who make deposits and take a tax deduction for them.

Contributions

There are limits to the amount of contributions you can deposit to both a 401k plan and an IRA, although they are very different. In 2011, employees under age 55 can defer up to $16,500 of their wages into a 401k plan, and add $5,500 if they are over 55. Employers can add matching or other contributions as well. IRA contribution limits are much lower: $5,000 for those under 55 with an additional $1,000 for those older. The entire value of an employee 401k contribution is not taxed until withdrawal, while the total amount of your IRA contribution that you can deduct may be limited if you participate in both a 401k and an IRA, or if your income is above certain levels.

Distributions

In general, distributions from either plan will incur a tax penalty if you withdraw them before age 59 1/2. There are some exceptions to this rule -- if you rollover the withdrawal to another qualified plan, a 401k or IRA, or if you become disabled, have a medical hardship, or take periodic payments for no less than five years. Some 401k plans allow participants to withdraw funds, with a penalty, if they have a financial hardship or are purchasing a home; some plans also allow participants to take loans. IRA owners may withdraw funds for a first time home purchase or qualified educational expenses without incurring a penalty. You cannot take a loan from an IRA. For traditional IRAs and 401k plans, you must begin taking distributions by age 79 1/2.

Roth Option

IRAs and some 401k plans may be set up as Roth plans. For these plans, contributions are taxed in the year of deposit, but earnings are never taxed, provided they are withdrawn by the Roth IRA and 401k rules. These withdrawal rules are essentially the same as those for traditional plans, but do not have a required distribution date during the owner's lifetime.

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