In today’s DueNorth Insight we’re going to talk about the characteristics and key differences between IRAs and 401(k)s as well as Roth IRAs and Roth 401(k)s. We’ll start by looking generally at IRAs and 401(k)s. 401(k) plans are employee sponsored plans that often include an employer match component to incentivize employee savings.
IRAs on the other hand stands for Individual Retirement Account, which are established directly by the individual. Both 401(k)s and IRAs are subject to contribution limits. In 2021 these limits are $6,000 for IRAs and $19,500 for 401(k)s.
Looking specifically at Roth IRAs and Roth 401(k)s, the word “Roth” means “After-tax.” Contributions to these accounts are made with after-tax dollars and grow tax free. Roth IRAs are not subject to required minimum distributions; it is important to know that a Roth 401(k) is subject to these rules if it’s not rolled into a Roth IRA by age 72.
Transitioning now to look at Traditional IRAs and 401(k)s. These accounts are funded with pre-tax dollars, your investment grows tax deferred, but it is taxed at ordinary income upon making a qualified distribution. Both 401(k)s and Traditional IRAs are also subject to the rules of Required Minimum Distributions.
As you can see, the key difference is the timing of the taxation. A Roth 401(k) and Roth IRA provide no tax benefit in the current year; however, their growth is never taxed again. On the other hand, traditional 401(k)s and IRAs provide a tax benefit in the current year but are subject to ordinary income taxes upon making a qualified distribution. And that’s today’s DueNorth Insight.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.