5 Things You Can Do With a 401(k) That You Can’t With an IRA

By Jeffrey Levine, Director of Retirement Education
Follow us on Twitter: @IRAGuru4EdSlott

401(k)s and IRAs share a lot of similarities. They are both retirement plans. They both can help you lower your tax bill today, provide tax-deferred growth and can help provide an income source in retirement. That said, there are also many differences between the two types of retirement accounts. Some are relatively insignificant and probably won’t impact your planning or decision-making process, but other differences can make one type of account far superior to the other in your particular situation. With that in mind, today, we explore 5 things you can do with a 401(k) that you can’t do with an IRA.

Take a Loan
Although doing so is completely at a plan’s discretion, many 401(k) plans incorporate a loan provision into their terms. If you are a participant in such a plan, you may be able to access as much as $50,000 (the precise amount you can take as a loan may be lower and is based upon your total plan assets) from your 401(k) plan tax-free. Should you choose to take such a loan, you’ll generally need to pay down that debt, plus interest, over no longer than 5 years. And you’ll have to do so in substantially equal payments. Although it’s generally best to avoid such loans, sometimes there’s little to no alternative. In contrast, loans are a prohibited transaction when it comes to IRAs. Taking a loan of even a single dollar from your IRA will result in the complete distribution of the entire account.

Avoid Required Minimum Distributions After 70 ½
If you have an IRA, you must begin taking required minimum distributions (RMDs) from that account when you reach age 70 ½. There are no exceptions. In contrast, while the same obligation generally exists for any 401(k) assets you have, there are exceptions. For instance, so long as you don’t own more than 5% of the company sponsoring your 401(k), and you are still working there, you can delay RMDs until you retire, provided your plan allows. There is no precise definition of “still working,” so even if you’re just working nominal hours as a consultant to your “old” employer, you may still be able to defer RMDs from your 401(k), so long as the company still considers you an employee. If you receive a paycheck and get a W-2 at year’s end, it’s a pretty safe bet that you will be considered “still working.” Note, however, that once you retire, regardless of when during the year that retirement occurs, RMDs must begin for that year.

Take a Penalty-Free Distribution After Retiring at 55
In general, distributions taken from a retirement account prior to age 59 ½ are subject to income tax and an additional 10% early distribution penalty. The law does, however, provide for a number of exceptions to this rule. One such exception is available if you take a distribution from your 401(k) after retiring (or otherwise separating from service) from the company sponsoring that plan at age 55 or later. In contrast, you must be at least 59 ½ to be able to withdraw money from your IRA penalty free (unless another exception applies).

Lower Your Tax Bill Via Deferrals Regardless of Your Income
In general, you can lower your tax bill by either contributing to a traditional IRA or by deferring portions of your salary into a 401(k). If, however, your income is too high, and you and/or your spouse are an active participant in an employer plan (like a 401(k)!), your ability to take a deduction for a contribution to a traditional IRA can be reduced, or eliminated altogether. With a 401(k), however, there are no similar limits. Even if both you and your spouse earn $1 million each year and you are both active participants in a 401(k), both of you can defer the maximum amount allowed under law – $18,000, or $24,000 if 50 or older by the end of the year – into your 401(k) plans to reduce your taxable income.

Contribute to a Roth Account Regardless of Your Income
Today, many 401(k) plans include a Roth 401(k) option. While Roth 401(k)s are similar to Roth IRAs in many ways, there are also a number of key differences between the two accounts. One such difference is that there are no income limits for Roth 401(k) salary deferrals. Whether your salary is $25,000 per year or $25 million per year, you can defer the maximum amount allowed under law – $18,000, or $24,000 if age 50 or older by the end of the year – into a Roth 401(k). While you will receive no current tax benefit for doing so, your deferrals will grow inside the Roth account and will be available for tax-free withdrawals in retirement (provided certain rules are met). Roth IRAs, on the other hand, do have income limits. If your income is too high, your ability to contribute to a Roth IRA can be reduced or eliminated entirely.

So there you have it, five things you can do with a 401(k) that you can’t do with an IRA! Does that mean 401(k)s are better than IRAs? No, of course not. They’re just different. In fact, there are many options available to IRA owners that aren’t available to 401(k) participants. So if you have the option of deciding where to hold your retirement assets, make your choice wisely and only after thoroughly investigating all available options.