Comparison of 401(k) and IRA accounts

This is a comparison between 401(k) and IRA accounts.

Comparison

Tax Year 2008	401(k)	Roth 401(k)	Traditional IRA	Roth IRA
Tax Implications	Money is deposited as "tax deferred" and then taxed at normal income bracket for distributions	Income is post tax money and no taxes have to be paid under normal distributions	Contributed money is at first post tax money. However, contributions are tax deductible which reduce your tax basis for that tax year. Then, distributions are taxed at the normal income for distributions. Tax deductibility is limited by MAGI and participation in pension or 401k.	Income is post tax money and no taxes have to be paid under normal distributions
Income Limits	Generally none, but somewhat complicated due to HCE (highly compensated employees) rules	Generally none, but somewhat complicated due to HCE (highly compensated employees) rules	Based upon MAGI; Single, HoH, MFS: full contrib to $53k, partial to $63k; MFJ; QW: full contrib to $85k, partial to $105k; can't contribute more than you make in that year	Based upon MAGI; Single: full contrib up to $101k, partial contrib to $116k; Married: full contrib up to $159k, partial contrib to $169k; can't contribute more than you make in that year
Contribution Limits	$15.5k/yr for under 50, $20.5k/yr for 50 and over in 2008; limits are a total of trad 401(k) and Roth 401(k) contributions. Employee and employer combined contributions must be lesser of 100% of employee's salary or $46k.	$15.5k/yr for under 50, $20.5k/yr for 50 and over in 2008; limits are a total of trad 401(k) and Roth 401(k) contributions. Employee and employer combined contributions must be lesser of 100% of employee's salary or $46k.	$5k/yr for age 49 or below; $6k/yr for age 50 or above in 2008; limits are total for trad IRA and Roth IRA contributions combined	$5k/yr for age 49 or below; $6k/yr for age 50 or above in 2008; limits are total for trad IRA and Roth IRA contributions combined
Employer or Individual	Employer sets up this plan	Employer sets up this plan	Individual sets up this plan	Individual sets up this plan
Matching Contributions	Matching contributions available from employers.	Matching contributions available through employers, but they must sit in a pretax account	No matching contributions available	No matching contributions available
Distributions	Distributions can begin at age 59 1/2 or if owner becomes disabled	Distributions can begin at age 59 1/2 and the account has been open for at least 5 years; there are exceptions though	Distributions can begin at age 59 1/2 or owner becomes disabled	Distributions can begin at age 59 1/2 as long as contributions are "seasoned" (been in the account for at least 5 years) or owner becomes disabled
Forced Distributions	Must start withdrawing funds at age 70 1/2 unless employee is still employed. Penalty is 50% of minimum distribution.	Must start withdrawing funds at age 70 1/2 unless employee is still employed. Penalty is 50% of minimum distribution.	Must start withdrawing funds at age 70 1/2 unless employee is still employed. Penalty is 50% of minimum distribution.	None, and this is a huge benefit for Roth IRAs.
Contribution Withdrawal	No, but loans from this plan are available depending upon employer's plan	Yes, as long as the account has been open for more than 5 years, however the proportion of withdrawal equal to the to proportion of profits to contributions in the account is subject to 10% penalty plus taxes	No	At any point, the owner may withdraw the total contributed into the IRA
Early Withdrawal	10% penalty plus taxes including withdrawal for hardships	Proportion of withdrawal equal to the to proportion of profits to contributions in the account is subject to 10% penalty plus taxes including withdrawal for hardships	10% penalty plus taxes for distributions before age 59 1/2 with exceptions	Early withdrawal that is more than contributions plus seasoned conversions are subject to normal income taxes and 10% penalty if not qualified distributions
Home Down Payment	Purchase of primary residence and avoidance of foreclosure or eviction of primary residence is subject to 10% penalty.	???	Can withdraw up to $10k for a first time home purchase down payment with stipulations	Up to $10k can be used for primary home down payment. Must not have owned a home in previous 24 months. House must be owned by IRA owner or direct linear ancestors or descendants.
Education Expenses	Payment of secondary educational expenses in last 12 months for employee, spouse, or dependents subject to 10% penalty	???	Can withdraw for qualified education expenses of owner, children, and grandchildren	Can withdraw for qualified education expenses of owner, children, and grandchildren
Medical Expenses	Medical expenses not covered by insurance for employee, spouse, or dependents subject to 10% penalty	???	Can withdraw for qualified unreimbursed medical expenses that are more than 7.5% of AGI; medical insurance during period of unemployment; during disability	Can withdraw for qualified unreimbursed medical expenses that are more than 7.5% of AGI; medical insurance during period of unemployment; during disability
Conversions	Upon termination of employment, can be rolled to IRA or Roth IRA. When rolled to a Roth IRA taxes need to be paid during the year of the conversion.	Cannot be converted to a trad 401(k), but upon termination of employment, can be rolled into Roth IRA	Can be converted to a Roth IRA. Taxes need to be paid during the year of the conversion. Other limitations though.	???
Changing Institutions	Can roll over to another employer's 401(k) plan or to a traditional IRA at an independent institution.	Can roll over to another employer's Roth 401(k) plan or to a Roth IRA at an independent institution.	Funds can be either transferred to another institution or they can be sent to the owner of the trad IRA who has 60 days to put the money in another institution in a rollover contribution to another traditional IRA	Funds can be either transferred to another institution or they can be sent to the owner of the Roth IRA who has 60 days to put the money in another institution in a rollover contribution to another Roth IRA
Inside The Account	Capital gains, dividends, and interest within account incur no tax liability	Capital gains, dividends, and interest within account incur no tax liability	Capital gains, dividends, and interest within account incur no tax liability	Capital gains, dividends, and interest within account incur no tax liability
Beneficiaries	???	???	When owner dies, spouse as beneficiary can roll both accounts into one IRA account. Other beneficiaries will be subject to forced distributions (taxable) based on life expectancy. Beneficiaries will not pay estate tax if the inheritance is under the exemption amount. IMPORTANT! To qualify, beneficiary MUST be named on the appropriate IRA beneficiary form. The beneficiary will be subject to estate tax if they inherit an IRA solely through a will.	When owner dies, spouse as beneficiary can roll both accounts into one Roth IRA account. Other beneficiaries will be subject to forced distributions (tax free) based on life expectancy. Beneficiaries will not pay estate tax if the inheritance is under the exemption amount. IMPORTANT! To qualify, beneficiary MUST be named on the appropriate IRA beneficiary form. The beneficiary will be subject to estate tax if they inherit an IRA solely through a will.
Other	???	Seldom offered by employers since it was implemented in early 2006	???	???

IRA: Roth vs. Traditional

The decision between choosing a Roth IRA vs. a Traditional IRA depends mostly on whether you are likely to be in a higher tax bracket in the future (in which case a Roth IRA is better) or a lower tax bracket in the future (in which case a conventional IRA is better). Roth IRAs also have a bit more flexibility in terms of early withdrawal. If your tax bracket does not change while you are working vs. when you retire, you will end up with the same amount of money in a Roth IRA as a conventional IRA for a donation less than the maximum allowable. If you save the maximum allowable amount in an IRA, and you stay in the same tax bracket, there is a slight tax advantage to the Roth-IRA as the following example illustrates:

Roth IRA. A $4000 contribution to a Roth-IRA growing at a constant (and riskless) rate of 10% will, in 25 years, grow to 4000 * 1.1²⁵ = $43,338.82. Because this $4000 contribution is not tax-deductible, the contribution plus the tax will cost 4000 / (1-.25) = $5333.33 in the year of contribution (i.e. the taxes on $5333.33 earned will be $1333.33, leaving $4000 to invest).

Traditional IRA. If $5333.33 is put into a conventional IRA, $4000 of this contribution will grow tax-deferred. This will grow to $43,338.82 in 25 years using the same assumptions and calculations above. The tax on this amount will be 25% * 43,338.82 = $10,834.71, leaving 43,338.82 - 10,834.71 = $32,504.12 from the IRA account. However, the investor will have 5333.33 - 4000 = $1333.33 left to invest in a "naked" (i.e. taxable) account. Taxed every year, this amount will grow to 1333.33 * (1 + .1 * [1-.25])²⁵ = $8131.12. This implies a total, after-tax amount of 32,504.12 + 8131.12 = $40,635.24.

Explanation. The Roth IRA is better because withdrawals of earnings are tax-free. (After 25 years earnings are $43.338.82. However taxes are paid only on $5333.33)

Another reason is that the $1333.33 tax savings in the year of the contribution cannot grow in a tax-deferred account. If this amount were able to grow in a tax-deferred account, then the $1333.33 would grow to 1333.33 * 1.1²⁵ = $14,446.27, and if taxed at 25% upon withdrawal would imply 14,446.27 * .25 = $3611.57 in taxes, leaving 14,446.27 - 3611.57 = $10,834.71. Adding this to the $32,504.12 amount from the Traditional IRA savings equals 32,504.12 + 10,834.71 = $43,338.82, just like in the Roth IRA. Since the maximum IRA contribution is imposed after taxes are paid for Roth-IRA contributions, there is effectively a tax-deferral advantage for Roth contributions when, and only when, an individual is making the maximum contribution allowed.

External links

• Roth vs. Traditional IRA Calculator
• 401(k) vs Roth IRA
• Decision factors
• The Value of a Roth in an Estate
• RetirementDictionary Definition