IRAs & 401(k)s - what is it? What is the difference?

Answer 1

They're two different kinds of retirement accounts, where you put money in now and it grows until you retire. They both allow tax-free growth of your investment, which saves you a lot of money in the long run.

A 401(k) is administered through your employer. They usually offer a limited number of investment choices. You can contribute money from your paycheck to your 401(k) before taxes, which amounts to a tax deduction. Many employers offer matching contributions, which means if you put money in, they will too. That's a great deal, because it's free money. Your employer can help you set up those contributions.

An IRA, or Individual Retirement Account, is not connected to any employer. You can open one at virtually any financial institution, and you can choose any investment you want. Vanguard (www.vanguard.com) is a good place to start. If you call them they can answer questions and walk you through the process.

IRAs come in two flavors: traditional and Roth. The difference is in when they're taxed. In a traditional IRA, the money is taxed after you retire and take the money out. In a Roth, you pay income taxes now on the money you put in, but not when you take it out during retirement. If you're not sure which one to do, ask your investment company or just go with a Roth.

You can contribute to both a 401(k) and an IRA, and I encourage you to do so. If your employer offers matching contributions, contribute to your 401(k) first, then an IRA if you have money left over.

Answer 2

Two very different beasts.

401(k) is an employer-sponsored plan. When you employer provides matching funds, you should contribute the maximum amount that will be matched. Your employer is giving you free money!

IRA is self-directed. You can put away up to $4000 per year. Two flavors of IRA: Traditional and Roth.

Traditional IRA lets you accumulate funds tax deferred. Money goes in tax free (current year deduction against income). Money comes out taxable at the future tax rate.

Roth IRA lets you accumulate funds tax free. Money goes in already taxed and comes out tax free.

Roth IRA is better IF you think your tax bracket will be higher upon retirement. Traditional IRA is better if you think your tax bracket will be lower upon retirement. If you tax bracket is the same, it doesn't matter which you choose.

Answer 3

chapter 24 of my book explains all of it http://www.invest-for-retirement.com