The biggest difference between two most popular types of retirement accounts — 401(k) and IRA — is that 401(k) plans are set up by employers and IRAs are individual retirement accounts, thus the acronym. With 401(k) accounts, contributions are made on a pre-tax basis. Contributions to IRA accounts are made with post-tax income but tax deductions are available for these contributions. With both IRA and 401(k), investments grow on a tax-deferred basis but at the time of withdrawal, taxes are due at the then-current tax rate.

There are different contribution limits and tax considerations for both types of plans, as explained below.

Comparison chart

401(k) versus IRA comparison chart
Edit this comparison chart401(k)IRA
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Plan set by Employer Individual
Contribution Limits Employee contribution limit of $18,000 (under 50 yrs old), $24K (50+); limits apply to combined total contributed to 401k and Roth 401k. Employee and employer combined contributions must be lesser of 100% of employee's salary or $53,000. $5,500/yr for age 49 or less; $6,500/yr for age 50+; limit is for combined contributions to traditional IRA and Roth IRA.
Income Limits Generally none, but somewhat complicated due to HCE (highly compensated employees) rules Based upon MAGI; Single, HoH, MFS: full contrib to $61,000, partial to $71,000; MFJ; QW: full contrib to $98,000, partial to $118,000. Can't contribute more than you earn in that year.
Employer contributions Often Rarely
Investments in the account Stocks, Bonds, Mutual Funds. Capital gains, dividends, and interest within account incur no tax liability. Stocks, Bonds, Mutual Funds, Real Estate (Only in specific types of IRA's). Capital gains, dividends, and interest within account incur no tax liability.
Tax Implications Money is deposited as tax-deferred and grows tax-free in the account. Gains in the account are not taxed. Distributions from the account are considered ordinary income and taxed accordingly. (some exceptions for after-tax contributions where allowed) Contributions may be tax-deductible subject to income limits. Gains in the account are not taxed. Distributions from the account are considered ordinary income and taxed accordingly.
Distributions Distributions can begin at age 59 1/2 or earlier if owner becomes disabled. Distributions can begin at age 59½ or owner becomes disabled.
Forced Distributions Must start withdrawing funds at age 70 1/2 unless employee is still employed. Penalty is 50% of minimum distribution Must start withdrawing funds at age 70½ unless employee is still employed. Penalty is 50% of minimum distribution
Borrowing against Account Depending upon the plan, borrowing against funds in the account is allowed up to 50% of the account value but only if still employed with the same employer. No
Early Withdrawal 10% penalty plus taxes. Early withdrawal restricted to employee contributions; employer contributions cannot be withdrawn early. Exceptions for financial hardships, but 10% penalty applies even in those cases. 10% penalty plus taxes for distributions before age 59 1/2 with exceptions.
Early Withdrawal for Medical Expenses Medical expenses not covered by insurance for employee, spouse, or dependents subject to 10% penalty Can withdraw for qualified unreimbursed medical expenses that are more than 7.5% of AGI; medical insurance during period of unemployment; during disability
Early Withdrawal for Homebuyers Purchase of primary residence and avoidance of foreclosure or eviction of primary residence is subject to 10% penalty Can withdraw (without the 10% tax penalty) up to $10,000 for a first time home purchase down payment with stipulations
Early Withdrawal for Educational Expenses Payment of secondary educational expenses in last 12 months for employee, spouse, or dependents subject to 10% penalty Can withdraw without the 10% tax penalty for qualified education expenses of owner, children, and grandchildren.
Conversions Upon termination of employment, can be rolled to IRA or Roth IRA. When rolled to a Roth IRA taxes need to be paid during the year of the conversion Can be converted to a Roth IRA. Taxes need to be paid during the year of the conversion. Other limitations may also apply.
Withdrawals Taxed as ordinary income Taxed as ordinary income (distributions from Roth IRAs are not taxed)
Changing Institutions Can roll over to another employer's 401(k) plan or to an (traditional) IRA at an independent institution Funds can be either transferred to another institution or they can be sent to the owner of the traditional IRA who has 60 days to put the money in another institution in a rollover contribution to another traditional IRA.

History of IRA and 401(k) plans

In 1978, the United States Congress amended the Internal Revenue Code to add section 401(k). Work on developing the first plans began in 1979. Originally intended for executives, section 401(k) plans proved popular with workers at all levels because it had higher yearly contribution limits than the Individual Retirement Account (IRA); it usually came with a company match, and provided greater flexibility in some ways than the IRA, often providing loans and, if applicable, offered the employer's stock as an investment choice. Several major corporations amended existing defined contribution plans immediately following the publication of IRS proposed regulations in 1981.

A primary reason for the explosion of 401(k) plans is that such plans are cheaper for employers to maintain than a pension because, instead of required pension contributions, they only have to pay plan administration and support costs if they elect not to match employee contributions or make profit sharing contributions. In addition, some or all of the plan administration costs can be passed on to plan participants. In years with strong profits employers can make matching or profit sharing contributions, and reduce or eliminate them in poor years. Thus, unlike the IRA, 401(k) creates a predictable cost for employers, while the cost of defined benefit plans can vary unpredictably every year.

What are 401(k) & IRA?

A 401(k) is a type of employer-sponsored retirement plan that allows employees to save for retirement while deferring federal income taxes on the saved money and accumulated investment earnings until funds start being withdrawn from the account during retirement.

The employee chooses to have a portion of his or her salary paid directly, or "deferred", into his or her 401(k) account. In participant-directed plans (the most common option), the employee can select from a number of investment options, usually an assortment or mix of mutual funds that emphasize stocks, bonds, money market investments. Many companies' 401(k) plans also offer the option to purchase the company's stock. The employee can generally re-allocate money among these investment choices at any time. In the trustee-directed 401(k) plans, the employer appoints trustees who decide how the plan's assets will be invested.

Individual Retirement Account (IRA) is a retirement plan account that provides some tax advantages for retirement savings in the US. The individual retirement arrangement and related vehicles were created by amendments to the Internal Revenue Code of 1954 (as amended) made by the Employee Retirement Income Security Act of 1974 (ERISA), which enacted (among other things) Internal Revenue Code sections 219 (26 U.S.C. § 219) and 408 (26 U.S.C. § 408) relating to IRAs.

Eligible income levels for 401(k) and IRA

401(k) has no regulations on income levels for the LCE & MCE, but the regulations for HCE (highly compensated employees are defined as employees with compensation of $100,000 or greater in 2006 and remains unchanged for 2007) greatly complicate it.

Contribution limits to an IRA are based upon income (specifically, MAGI on the tax return). Below a certain income threshold, you are allowed to contribute up to the full amount, which is $5,500 per individual for 2016. Individuals over the age of 50 can contribute an additional $1,000. These limits are per individual so the limits are effectively double for married couples. However, if your income is above a certain threshold, the contribution limits start decreasing as follows:

Differences in Withdrawal Options

Early Withdrawal

Both the 401(k) and IRA are retirement accounts so they are structured to discourage early withdrawals. 401(k) plans generally do not allow withdrawals while still employed with the employer setting up the plan. Some employers set up their 401(k) plans to allow for withdrawals in the case of financial hardship, but even in such scenarios, it is typically the employee's contributions that can be withdrawn and not the money that was contributed by the employer. IRA accounts are owned by the individual so early withdrawals are allowed, although subject to certain taxes.

If you choose to withdraw funds from either type of account before the age of 59½, there is a 10% penalty (in the form of a 10% tax). And since income taxes were deferred when the funds were contributed to the account, those taxes are due at the time of withdrawal. The taxes and penalties apply even if it's a hardship withdrawal.


One advantage of a 401(k) plan is that you can borrow money against it. Generally the loan amount is limited to 50% of the balance in the 401(k) account.

It is not possible to borrow against funds in an IRA.

Distributions in Retirement

After the age of 59½ you can take distributions from your retirement accounts, including 401(k), IRA and Roth IRA. The funds you withdraw from these accounts are considered ordinary income; they are therefore taxed like ordinary income. Both federal and state taxes are due on this income.

There are no taxes due on distributions from a Roth plans, as discussed below. This applies to both Roth IRA and Roth 401(k) accounts.

Differences with the Roth schemes

To encourage saving for retirement, growth of funds in retirement accounts is tax-free. This means capital gains, dividends and interest earned in your retirement account — whether it's a 401(k), IRA or their Roth counterpart — is always tax-free.

However, taxes are due at least once: either when you contribute money into or when you take funds out of a retirement account. With a traditional 401(k) and traditional IRA, contributions are tax-deductible but income taxes are due on distributions. Withdrawals from a traditional IRA or 401(k) during retirement are considered ordinary income and taxed accordingly. With Roth accounts, contributions going in are not tax-deductible and are made from after-tax dollars; however, distributions going out in retirement from these accounts are tax-free.

So if you are in a lower tax bracket now and can contribute to a Roth plan, you should do so. Your money will grow tax-free and no taxes will be due even when you take that money out.

The decision between choosing a Roth IRA vs. a Traditional IRA depends mostly on whether you are likely to be in a higher tax bracket in the future (in which case a Roth IRA is better) or a lower tax bracket in the future (in which case a conventional IRA is better). Roth IRAs also have a bit more flexibility in terms of early withdrawal. If your tax bracket does not change while you are working vs. when you retire, you will end up with the same amount of money in a Roth IRA as a conventional IRA for a contribution less than the maximum allowable. If you save the maximum allowable amount in an IRA, and you stay in the same tax bracket, there is a slight tax advantage to the Roth-IRA.


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