IRAs and 401Ks: The Difference Explained

IRAs and 401Ks: The Difference Explained

Saving plan

Squirrelling away money for retirement is good financial practice. We all need to take responsibility for our future financial security, and the earlier employees begin putting money aside for their old age, the more secure their post-working years will be.

Two terms usually dominate any discussion on retirement financial planning: 401K and IRA. Both are used as effective methods to save money for your retirement. However, there are subtle differences between the two. They are not one and the same, and one or the other will be better suited to your financial circumstances.


An individual retirement account (IRA), often referred to as a self-directed IRA, is essentially an account designed to save for your retirement. Unlike other accounts, you are not limited in how you invest your IRA funds. You can invest it in traditional investment avenues, like stocks, bonds, and mutual funds, or you can pursue alternative investment options, like real estate and commodities. You can find more information on IRAs here:


It is important to note that the self-employed also have IRA and 401k considerations you’ll want to research.


Named after the section of the tax code which discusses retirement, the 401K is a retirement plan that is linked to your employment. Unlike the IRA, the 401K can only be offered to employees through an employer.

Employers will usually match a portion of the employees 401K contributions. For every dollar the employee invests in their 401K, the employer will also invest an agreed percentage.

Typically, 401Ks do not have the same investment freedom that IRAs offer. 401K providers will offer a choice of several investment options, usually reflected by a risk tolerance (low-risk, medium-risk, or high-risk).


One of the key ways a 401K differs from an IRA is over tax. 401K contributions are tax deductible. No matter what your income, you can make pre-tax contributions.

Traditional IRA contributions can be tax deductible, but only if your modified adjustable gross income (MAGI) is under the specified legal limit.


401Ks and IRAs also have different legislation regarding contribution limits. Employees under 50-years-old are free to make contributions in a 401K providing they do not exceed $18,500 annually. For employees over 50, the contribution limit is slightly higher at $24,500 a year.

IRAs are more limited. Anyone under 50 has a yearly IRA contribution limit of $5,500. Once you reach 50, you are permitted an additional $1,000 a year, bringing the limit up to $6,500 annually.


Occasionally, when investors fall on times of extreme hardship, they are forced to take out a portion of their retirement fund as a loan. 401Ks usually permit this, but IRAs have severe restrictions on what you can withdraw from the fund before retirement age.

If you need the money to buy your first home, your IRA provider should permit you to withdraw up to $10,000 from your IRA as a loan. In other scenarios, loans can be obtained, but often come with the caveat that the money is returned to the fund within 60 days.


Federal law dictates that your spouse is the automatic recipient of your 401K in the event of your premature death. However, with an IRA, you have the freedom to nominate whoever you desire as a beneficiary.

Whether you take the route of an IRA or a 401K depends on your personal circumstances and the retirement options available to you through your employer. Both have their positives and their negatives. The important thing is that you have something saved for you old-age to help give you peace of mind and comfort in the final years of your life.