How To Compare 401k And IRA?

The 401 K plan and Roth IRA account both work on the basic principle of promoting tax exempted growth of money. The money accumulated under any of this retirement scheme is used by the employee for investing in profitable ventures and ensuring a large balance at the time of retirement.

The vital difference between these plans is the requirements and the conditions of contribution and benefits. When you want to compare 401 K and IRA, it is a must to know the Roth IRA requirements.

Both these IRA plans have their share of pros and cons. The 401k retirement plan is the older of these individual retirement plans and was put in place in 1978. This scheme became very popular as it was the first combined saving and investment scheme of its kind. Then in 1997, William V. Roth, Jr., a Senator from Delaware, introduced a legislation that led to the creation of Roth IRA .This was an addition to the existing IRAs. It gained wide popularity as its withdrawals were tax free and contributions could continue even after retirement.

In the first plan, the contribution to the account is before tax deduction. You do not pay tax on the amount that you have contributed. In IRA, contribution to the account is made after the due tax has been calculated and deducted from it.

In the traditional 401 K plan, the amount of contribution is much higher. An individual can contribute 1-15% of his income or $ 14000. The ceiling is reviewed every year by the IRS. It was $ 15000 for the year 2006. On the other hand, in a Roth IRA account there are separate limitations for married and single earning individuals.

For married couples, it is $166,000 and for single person it is $114,000 of MAGI (both figures for 2007). In both these plans the ceiling on the amount of contribution is raised for those who have turned 50. In the case of 401 K plan the contribution is $20,000 and in case of IRAs it is $5000. The biggest difference to take heed to when you want to compare 401 K and IRA is the tax on withdrawal, a situation in which a Roth IRA has a definite edge over the 401 K plan.

While the withdrawal from the 401 K plan will be subjected to tax deductions according to prevalent income tax rates, the withdrawals from the IRA account would be tax free. Again, with the Roth IRA account there is no age limit on your account contribution but with the 401 K plan you have to cease contributing at the age of 70 .

With the rate of taxation moving upwards in the last decade, the advantage of the 401k plan has considerably reduced. Though the 401 K plan seems to be less suitable, it is important to note that the amount of contribution you are allowed to make in a 401 K is almost three times higher than what is permissible in any IRA scheme. 401 K is suitable only if the account is opened five years before the retirement, and the tax rate is lower at the time of retirement. To compare 401k and IRA, you must know the rules, requirements, and conditions to effectively decide which is better for you.