What’s the difference between IRA and 401(k)?

One of the more viable ways to secure cash for a down payment on your dream home is through your retirement fund. Before you even think about it, you may stop and think about what retirement fund would be the best setup for you. In doing so, it’s impossible that both the IRA and 401(k) plans never crossed your mind. These two offer lucrative tax breaks while giving your finances room to grow over time. While the two may serve a similar purpose, they have stark differences and this guide will help you all the way in sorting out the confusion between these two retirement plans.

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So, What’s the Big Difference?

Evaluating retirement plan options aims to keep 3 key considerations in mind: the amount you’ll contribute annually, the taxes on your contributions, and the date when you can make a withdrawal without the penalties.

With that in mind, let’s see what separates these two most preferred retirements plans apart:

IRA

Individual Retirement Accounts or IRAs is a type of savings account retirees can open on their own for long-term savings and investments. Anyone earning an income can open an IRA with any financial institution that offers retirement plans. It has three types of plans and they are:

Traditional IRA – this works like a conventional 401(k) minus the employer sponsorship and contributions. Account-holders get their savings up with pre-tax income with the option to deduct traditional IRA Contributions on annual taxes.

ROTH IRA – This type of account differs from its traditional counterparts because taxes are paid upfront. Taxed dollars are contributed right off the bat so account holders get to withdraw the full amount without deductions.

SEP IRA – Otherwise known as Simplified Employee Pensions, these account options are flexible retirement packages for self-employed professionals (entrepreneurs, freelancers, service contractors, and the like).

IRAs are Better…

If you seek financial flexibility in your retirement plan. Investments for these types of accounts can be anything of value from real estate, mutual funds, stocks, or bonds.

401(k)

This retirement package is exclusively employer-sponsored and has been a popular choice since the 80s when congress established the Revenue Act to encourage the working class to save up tax-free accounts in preparation for retirement. Funds are deducted from monthly income from a specific pay cutoff period and contribute to an investment account with an employer’s option of matching an employee’s contributions to the same account. Like an IRA, this retirement option has a Traditional and Roth variant with generally the same stipulations.

401(k)s are better…

If you’re serious about investing in your retirement without being too choosy on the available options. It can also come in the form of bonds, stocks, or securities, but they’re limited to what the sponsoring employer chooses.

Withdrawal Guidelines

For both retirement plans, account holders can withdraw their savings six months before they reach the age of 60. Early withdrawals are allowed but with a 10% penalty. For 401(k) there’s an additional income tax to be deducted on top of the penalty. Both have very limited rule exemptions and but IRAs have more relaxed rule exemptions when it comes to early withdrawals.

First-time homebuyers, for instance, are allowed to pull out up to $10,000 to be used as a down payment for their home purchase. The money should have already been used 120 days upon the date of withdrawal. Other exemptions include educational expenses for account holders or their family members, disability, medical expenses beyond 7.5% of adjusted gross income, birth or adoption expenses (up to $5,000), health insurance period (if the account holder is unemployed for more than 12 weeks.

For 401(k) accounts, the guidelines are much stricter with no exemptions being granted under any circumstances. For homebuyers who wish to tap their retirement plan to cover for a home down payment, a 401(k) loan is recommended because it lets account holders put out the necessary cash without the penalties, lower interest rates, and without affecting their debt-to-income ratio. Loan amounts, however, are limited to $50,000 or 50% of the vested account balance.

Disclaimer: Shop Owner Finance/ TL Global is not a lender. We are a real estate training agency. The Content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.