401(k)s, 403(b)’s and IRAs: What’s the Difference?
Saving for retirement is by far the most important financial goal many people have. Most individuals are familiar with the terms 401(k), 403(b) and IRA but do not really understand the differences between them. It is important to read your specific plan documents because each company sets up their employee benefit plan differently, following the Internal Revenue Code that governs them. Incidentally, this is precisely how and why these retirement plans got their names: from the subsection of the Internal Revenue Code that governs them, such as IRC subsections 401(k) and 403(b). IRA is an IRS abbreviation for Individual Retirement Arrangement, although we most often hear it referred to as an Individual Retirement Account.
There are a few key distinctions between Individual Retirement Accounts and employer sponsored plans such as 401(k)s and 403(b)’s. IRAs offer lower annual contribution amounts and your eligibility to deduct your contributions from your income is based on your modified adjusted gross income for the tax year that you make your contribution. For this reason, IRAs have an extension of time for contributions, generally until the tax filing deadline such as April 15th of the year following the tax year for which you are filing. Conversely, contributions for employer sponsored accounts must be made by the end of each calendar year, since there are no income limitations for eligibility to deduct the contributions. Employer sponsored plans have larger contribution thresholds than IRAs., and to sweeten the deal, employers may add money to 401(k)s and 403(b). The ability to contribute to your employer plan goes away once you are no longer employed by the company sponsoring the plan. Expenses vary and your investment choices within employer sponsored plans are limited to the options they have chosen for your plan, whereas investment options for IRAs are far greater and are chosen by you and your advisor if you work with one. Once you leave an employer, you generally have four options with your retirement account. You may keep the account where it is if the plan allows, or you may roll the account into another employer plan if the receiving plan lets you do so. You are allowed to cash the account out which would incur premature distribution penalties if you were under age 59 ½, as well as federal and state income taxes on the entire amount cashed out. The taxes and penalties are a hefty price to pay so this option is generally not recommended. Some people may choose a direct rollover option of their employer plan to their own IRA when they depart from their company so that they have control of the investment options and where the account is held. These are just a few examples of how employer plans differ from your own IRA.
LouAnn Schulfer is co-owner of Schulfer & Associates, LLC Wealth Management and can be reached at (715) 343-9600 or louann.schulfer@lpl.com. www.SchulferAndAssociates.com
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This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational presentation.
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.
