What is the Difference Between an IRA and a 401k

Many of my estate planning and elder law clients have questions revolving around their retirement accounts.  Sometimes it’s helpful to start at the basic level.  “What is the difference between an IRA and a 401k?”

The term 401k and individual retirement account (IRA) are thrown around quite a bit when discussing retirement planning and estate planning, but there are some large differences between the two accounts.

IRA vs. 401k

For starters, where there names.  A 401k is named as such due to the tax code that discusses it, while an IRA is an individual retirement plan.

Both IRAs and 401k’s allow you to put assets into an account to save for retirement.  Both allow you to begin taking distributions from these plans at age 59 1/2.

IRAs are further distinguished from 401k’s because there are two main types of IRAs.  There are Roth IRAs and traditional IRAs.  Roth IRAs allow you to pay the taxes up front and accumulate gains tax-free.  Compare that to your traditional IRA, where the taxes are paid only when you withdraw money.  A traditional IRA requires you to start taking minimum distributions at age 70 1/2, while a Roth has no such requirement.

Participation differs between IRAs and 401k’s.  In order to have a 401k, you must work for an employer that offers this as part of the benefit package.  Because this is indeed a benefit, an employer may limit who can join the plan.  An employer can then also make a contribution through deductions from a paycheck as well.

This differs from IRAs, where anyone who is younger than 70 1/2 and earns income can set up the IRA.  Typically, these are set up through a bank or financial institution.  As an individual, you are responsible for establishing the plan and contributing to it.

Beneficiaries of Your Retirement Accounts

An important point with both IRAs and 401k’s is who you name as a beneficiary.  By federal law, your spouse is automatically your beneficiary when you have a 401k, even if you list someone else.  To name someone other than your spouse as a beneficiary, you would need your spouse’s consent in writing.

An IRA allows you to name any beneficiary, with or without your spouse’s consent.

Standalone Retirement Plan Trust

Often times, it makes sense to name a Standalone Retirement Trust as the beneficiary of an IRA when leaving it to the next generation.  For more information on the benefits of the Standalone Retirement Plan Trust, contact our offices located in Brighton, Bloomfield Hills, Novi, or Livonia.

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