Most people have heard about 401ks and IRAs. But not everyone knows their differences even if they own one or both of these retirement accounts. Don’t worry. Up until 2 years ago, I didn’t know their differences either even though I owned a 401k.
Here are a few of their most notable differences:
- 401ks have to be opened and sponsored by your employer, while IRAs have to be opened by you. So if you’re currently not working or if you’re employer doesn’t sponsor 401ks, you wouldn’t be able to contribute to a 401k right now.
- 401ks have higher contribution limits than IRAs. For 2013, the contribution limit (max you can put into the account that year) is $17,500 for 401ks and $5,500 for IRAs.
- 401ks usually have limited investment options like specific mutual funds you have to choose from, while you can invest in almost anything in an IRA.
- 401k contributions are taken directly from your paycheck so you don’t pay taxes on the money until you take it out to use during retirement. IRAs are funded with after tax money but if you meet the requirements, you can get a deduction on your tax return.
As a general rule, if your employer sponsors a 401k plan, you should use it, especially if they have matching contributions. That’s free money right there!