Is 401k and traditional ira the same

Many companies offer 401(k) plans as a benefit to help workers prepare for their retirement years. If yours does, you can use a 401(k) to save a portion of your pretax income in an account set up by your employer. The amount you contribute is automatically deducted from your paycheck before it reaches you, just like your taxes and Social Security contribution. When you enroll in the plan, you'll be presented a choice of where you would like to invest your savings, in the form of mutual funds or exchange-traded funds.

To encourage participation in 401(k) plans, some employers will match contributions up to a certain amount, often a percentage of your annual income. For instance, if your company offers a 3% match, it will contribute payments equal to your contributions up to 3% of your salary. Therefore if your salary is $40,000, your employer will match your contribution dollar-for-dollar up to $1,200 a year. After that, you can continue to save, but your employer will stop donating the extra funds. An employer may also choose to match only a portion of your contribution—50 cents per dollar you contribute, for instance.

Another thing to know about 401(k) plans is that they tend to reward company loyalty through a process known as "vesting." To completely own all contributions to your 401(k), including your employer match, you must become "fully vested" or risk losing a portion of it if you leave your job. Vesting rules vary by plan; some plans vest an employee immediately, some do so gradually, and others vest all at once after several years.

What Is an IRA?

An IRA is another way to save and invest for your retirement, but it's something you can do on your own instead through an employer. You would open an IRA for yourself at a bank, credit union, investment firm, broker or through a mutual fund provider. The different types of IRAs are as follows.

• Traditional: You can save pretax earnings and, as long as you qualify, those contributions will reduce your taxable income. So if your salary is $40,000 and you save $5,000, your taxable income will be $35,000. Your contributions are instead taxable only when you begin to withdraw the funds.
• Roth: With this IRA, you contribute after-tax earnings. Your contributions and the money they make are not treated as income when they're withdrawn, so will not be subject to income tax.
• Spousal: You can open a separate traditional or Roth IRA so a working spouse can make contributions in the name of a non-working spouse. This way, both partners will have their own retirement account to tap into when the need arises.
• Rollover: When you switch employers, you can transfer the money in a 401(k) plan to a rollover (traditional) IRA. While you may be able to remain with your employer's plan, the rollover IRA can reduce fees and provide you with greater control over your investments.

Smaller companies that don't offer 401(k) plans have special IRAs available to them:

• Simplified employee pension (SEP): This plan allows business owners to contribute to both their employees' and their own retirement savings. It follows the same rules as traditional IRAs, but only the employers can contribute, not their employees.
• Savings Incentive Match Plan for Employees Individual Retirement Account (SIMPLE): This IRA has similar benefits to a 401(k), and employees can add money to their account with elective contributions from their paycheck.

Key Differences Between 401(k)s and IRAs

Knowing the broad ways each plan differs can help you decide if one is a better option for you. The devil is often in the details, however, and it's important to understand how each plan may differ in its practicality based on your employer, savings goals, when you plan to retire and other things.

How to Choose Between a 401(k) and IRA

Clearly both 401(k) plans and IRAs have their own advantages and disadvantages, but either can be crucial to helping you start saving for your retirement early. The sooner you do, the more money you'll accumulate for the years when you're no longer working. Some rules of thumb when deciding where to put your money:

If a 401(k) plan is available to you, maxing out your allowable contribution can be wise (as long as doing so won't impact your ability to make your bill payments). A 401(k) plan allows for higher contributions than IRAs, and any matched funds your employer contributes are essentially free money.

Have extra money to contribute after you've maxed out your 401(k)? As long as you meet the eligibility requirements, you can also contribute to an IRA.

In the event that a 401(k) plan is not an option, choose the right IRA for you. In general, a traditional IRA is preferable if you expect that your tax rate will decrease when you retire, and a Roth will be better if you think your taxes will be higher in retirement. There is no income limit for a traditional IRA, but there is an income limit for a Roth IRA.

If you haven't yet entered the world of 401(k) plans and IRAs, they may be intimidating. In the beginning, remember the basics: Take advantage of your employer's plan if one is available, save as much as makes sense for your budget and future needs, and select your investments wisely. The tax benefits of using these vehicles will get you to where you want to go without overpaying Uncle Sam.