ScaredyCatGuide to the 401(k) - Part 2: How IRAs Differ from the 401(k)

An Individual Retirement Account (IRA) is another type of investment plan that allows you to take advantage of special tax-related provisions set out by the US Government when saving for retirement. The biggest difference between a 401(k) plan and an IRA is the amount of money that can be invested in the plan each year.

IRA accounts are not typically contributed to by an employer. However, in recent years both the SIMPLE and SEP IRA have been offered by employers and gives them the option to contribute.

The beauty of most IRA accounts is the freedom. You're allowed to invest in stocks, bonds, gold coins, annuities and even real estate among other things.

There are many types of IRA plans, but below are the most common ones:

Traditional IRA

The traditional IRA was introduced during the mid 1970s, when a recession caused several changes in banking regulations that were designed to stimulate investment during the mid-1970s and early 1980s. They allow for investment funds to be more fluid as opposed to the 401(k), though contribution limits are more strictly capped.
In 2020, traditional IRA account holders may contribute up to $6,000 per year. That number increases to $7,000 for people over the age of 50.

Contributions to this account type are tax deductible against your income in the year they were made.

Roth IRA

Roth IRAs have been widely available since 1998. Contributions are not tax deductible when they are made, but distributions as long as you're of retirement age (currently set at 59½ years) and the account has been open for five years.

There are some exceptions to the distribution age rule items deemed as “qualified expenses” such as child birth, education or buying your first home. You can draw up to $10,000 lifetime cap for qualified expenses, but the five year rules still applies. Contribution caps are the same for the Roth as the traditional IRA.

SIMPLE IRA

The "savings incentive match plan for employees” or SIMPLE IRA is designed for small businesses with less than 100 employees. Employers can choose to make a 2% contribution to all employees or an optional matching contribution of up to 3%.

The employee contribute cap is $13,500 in 2020. Those over the age of 50 may make an additional catch-up contribution of $3,000, bringing their annual maximum to $16,500.

SEP IRA

A “simplified employee pension” or SEP IRA is available to self-employed workers and small businesses. In this type of plan employees do not contribute, just the employer.

Employers can make tax deductible contributions up to 25% of an employee’s salary or $57,000. Employees still direct the investment choices in the account from the options available in the plan.

The income is taxed upon withdrawal and like other plans penalty free withdrawals can begin at 59 ½ years old.

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