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The terms "401(k)" and "IRA" are sometimes used interchangeably, and both terms frequently come up during discussions about retirement savings. Specifically, a 401(k) is an employer-based retirement savings plan; an individual retirement account, or IRA, is an individual plan with the same basic purpose. There are other important differences to consider when determining which option is best for your needs and financial goals.

Differences With Taxes

There are no taxes to pay when you make contributions to a traditional IRA; you pay taxes when you withdraw the money. You may actually qualify for a tax deduction. Taxes are paid up front with a Roth IRA. With a traditional 401(k), you would pay income tax on withdrawals. If you have a Roth 401(k), you would pay tax on contributions you make, but there would be no tax on withdrawals.

Differences With Participation

A 401(k) is often part of an employer's benefits package. Contributions are made through paycheck deductions. An IRA can be set up for anyone younger than 70 through a bank or other financial institution offering such plans. You would be responsible for making your contributions.

Differences With Contributions

Employer contribution limits with a 401(k) are typically higher than limits for individuals. Employers also have the option to match all or part of employees' contributions. You are the only contributor to an IRA. However, some of your IRA contributions may be tax-deductible.

Differences With Investments

Investments with 401(k)s are usually limited, often in the form of mutual funds. IRAs tend to have several different investment options available, including real estate, stocks and bonds.


Differences With Loans

Loans are typically not permitted with IRAs. When they are permitted, the terms are usually very strict. For instance, you might have to pay it back within a short period of time. Loans are usually allowed with 401(k) plans although some employers limit them to "hardship loans" based on your situation.

Differences With Beneficiaries

Legally, your spouse, if you have one, is a beneficiary when you have a 401(k), even if you list another beneficiary. With an IRA, you determine the beneficiaries, and there's no requirement for your spouse to be one of them.

The decision between a 401(k) and an IRA will depend on several factors, including where you are in your career and your retirement goals. If retirement is years or decades away, a 401(k) may serve you better if you plan to stay with the same employer, but not so much if your employer limits who can participate or if you plan to change jobs soon. Tax consequences are also worth considering. A financial planner can provide further guidance based on your circumstances.

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