Q.
What's the difference between a 401(k) and an IRA?
A.
A 401(k) is a pension plan set up by your employer to which you contribute from your earnings (you'll pay taxes when you withdraw from the account but get the immediate benefit of investing with pre-tax dollars). Many companies offer matching contributions up to a certain amount -- yes, free money! In 2009, you can contribute up to $16,500, and there are penalties if you withdraw cash early.
Individual Retirement Accounts (IRAs) are private retirement funds set up at a bank or other investment brokerage. If you don’t have a 401(k), you can contribute up to $4,000 yearly and claim a tax deduction on your annual return. You're allowed to contribute more, but the law requires you to pay taxes on the amount first. The money grows in the investments you choose, and when you reach age 59 1/2, you can start taking out the money without penalty, paying taxes on any gains.
A Roth IRA is related, but different. You're allowed to contribute up to $4,000 per year as long as you pay income tax on the money, but when you start withdrawing after age 59 1/2, you don’t pay taxes on the gain. But if you and your spouse's annual gross salary is above $160,000, you're no longer eligible and should opt for a traditional IRA.
-- The Nest Editors
May 14, 2009
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