A 401(k) is an employer-sponsored retirement plan into which both employees and employers can make contributions. A rollover individual retirement account (IRA) is a personal retirement plan into which funds have previously been rolled over from another retirement account, such as a 401(k) or another IRA. Only an account owner can make contributions to a rollover IRA, not an employer. Both types of plans offer tax-deferred growth of contributions and earnings, along with tax-deductible contributions. However, the specific details of each type of account vary considerably.
Contributions
Contributions to a 401(k) are made on a salary reduction basis, where an employer takes your contribution out of your paycheck and directly deposits it in your 401(k) account. Some employers may make an additional matching contribution to your account on your behalf. For 2010, the contribution limit to a 401(k) plan is $11,500, or $14,000 if you are age 50 or older. With a rollover IRA, while you are permitted to make additional contributions, this takes away your ability to roll the funds over into another qualified plan, such as a 401(k) or profit sharing plan. IRA contributions must be physically deposited by you as the account owner. IRA contributions are limited to the lesser of $5,000 or the amount of your taxable compensation, although you may contribute an additional $1,000 if you are age 50 or older.
Loans
Loans are not permitted from any type of IRA, according to the IRS. However, you can take advantage of the rollover provision of IRAs if you want to take out a short-term loan. Once per year, the IRS allows you to make a tax-free withdrawal from your IRA, as long as you deposit the funds in the same or another IRA within 60 days. Thus, you can effectively "borrow" from your IRA for 60 days. Loans are permissible in 401(k) plans, although individual employers may choose not to offer them. With a 401(k) loan, you pay both interest and principal back to your own account through regular payments that generally last no longer than five years.
Rollovers
The IRS publishes a rollover chart which shows the types of allowable rollovers between various retirement plan types. Prior to December 31, 2007, qualified plans such as 401(k) plans could not be rolled over into Roth IRAs, but after that date, the rollover provisions for both 401(k) plans and rollover IRAs are essentially identical.
Taxation
Contributions to both 401(k)s and IRAs are generally made on a pre-tax basis. Contributions to 401(k)s are deposited to your account before they are taxed, whereas you may be able to claim a tax deduction on any IRA contributions you make. The deductibility or IRA contributions is outlined in IRS Publication 590, and depends on your tax filing status, modified adjusted gross income and whether or not you are covered by another retirement plan. Generally speaking, if you are not covered by an employer-sponsored retirement plan at work, you can deduct your IRA contribution. For both 401(k) and rollover IRA accounts, assets grow tax-deferred until distribution.
Distributions
Distributions from both a 401(k) plan and a rollover IRA are generally taxable at ordinary income tax rates. Additionally, if you take money out of either account before you reach age 59 1/2, you may be subject to a 10 percent early withdrawal penalty. You can generally take a withdrawal from an IRA for any reason, if you are willing to pay the taxes and penalties. However, it usually takes a life event, such as retirement or other separation from service, in order to take a 401(k) distribution.
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