Individual Retirement Accounts and 401(k) plans are both tax-advantaged retirement savings plans. While both provide tax-deferred growth of earnings and contributions, the provisions of these plans are very different. 401(k) plans are employer-sponsored plans, while IRA accounts are established by individual investors. Contributions to the plans are made in different ways, and the difference in contribution limits and deductibility can be significant.
Contribution Limits
According to the IRS, the 401(k) contribution limit for 2010 is $16,500, while for IRAs the limit is $5,500. Both types of accounts allow you to make an additional contribution if you are age 50 or older. This "catch-up" contribution is limited to $5,500 for 401(k) contributions, and $1,000 for IRA contributions. If you contribute to a 401(k) plan and your employer went bankrupt during the year, you are allowed to contribute up to $8,000 to an IRA plan. All contributions are limited to the extent of your taxable compensation. In other words, if you only earn $5,000 over the course of a year, your 401(k) contribution is limited to just $5,000, not $16,500.
Deductibility of Contributions
All 401(k) contributions are made on an pre-tax basis, regardless of how much you earn. For IRA contributions, the deductibility of your contributions is affected by your tax filing status, your modified adjusted gross income, and whether you or your spouse are covered by a retirement plan at work. If you are not covered by another plan, then your full IRA contribution is tax-deductible. However, if you are covered by an employer's plan, your IRA contributions are not deductible if you are a single filer with $105,000 or more in modified adjusted gross income. The same holds true if you are married filing jointly with a MAGI of $176,000 or higher. IRS Publication 590 provides a matrix outlining the deductibility of IRA contributions for all scenarios.
Manner of Contribution
401(k) contributions are made on a salary-deferral basis, meaning your employer will deduct part of your paycheck and deposit it in your 401(k) account on your behalf. IRA contributions are voluntary, meaning you must write a check or otherwise physically deposit your IRA contribution in your account. You are responsible for claiming the tax deduction for your IRA contributions when you file your taxes, but your 401(k) contributions will not appear as income on your W-2, so you do not need to file for a tax deduction.
Matching Contributions
Many employers match a portion of employee 401(k) contributions by making an additional deposit on behalf of employees. IRAs, on the other hand, are individual accounts to which employers do not make contributions.
Borrowing Contributions
Most employers will allow you to borrow up to 50 percent of the value of your 401(k), up to $50,000. The IRS does not allow you to borrow from your IRA. However, the rollover provision for IRAs does allow you to withdraw funds from your IRA once per year for up to 60 days, which can be used as a short-term loan.
Member Comments