Broker Check


February 15, 2024

The United States has available an assortment of different retirement plans, such as 401k, 403B, Cash Balance plans, multiple distinct IRA’s, Profit-Sharing Plans, and Pension Plans, etc. Typically, people are confused about which is the most suitable choice. Today, we will discuss the most used retirement plans: 401k and IRAs.


401k - Company-Sponsored Retirement Account


401k is the most frequently offered retirement plan by companies in the US. The difference between both plans is that 401k is a Defined Contribution Plan (aka DC Plan). For example, your employer offers a 401k plan to all employees. Each employee, as the plan participant, will have his or her own 401k account login and can voluntarily take deductions from payroll to contribute to the retirement account. Each company will select a 3rd-party professional 401k record-keeping platform to help track the asset and cover the fiduciary responsibility. The 401k account investment list is pre-determined by the employer, and usually has limited options.


There are two types of 401k accounts: Traditional 401k and Roth 401k.


Traditional 401K – NO TAX when contributing; TAX when withdrawing.


  1. Tax Deferral

Tax-Deferral ≠ Tax-Free.

When an employee contributes to a traditional 401k account, the contributions are pre-taxed money. For example, if you are a 30-year-old individual contributing $23,000 to your Traditional 401k, that same amount will be deducted from your paycheck and moved directly to your Traditional 401k account. That contribution is not going to be included in your 2024 taxable income, which means NO TAX for this $23,000 in 2024.

Let’s assume your account grows 4% annually for 30 years. When you reach 60, your $23,000 will grow to $74,598. When it is time for you to take out that $74,598 from your 401k account, you will pay the ordinary income tax for that amount.


  1. Company Match

If the employers want to provide better benefits to attract talent, they can offer the company match option within their 401k plan.

For instance, if you contribute $23,000 to the Traditional 401k account and your employer decides to match half of that amount ($11,500), the company match will increase the total contribution amount in that year by $11,500, which is not included in your taxable income. The match amount is determined by your company’s benefit plan, which may vary between companies. As an employee, the maximum amount you can contribute to your 401k plan in 2024 is capped at $23,000.

However, the total 401k contribution amount (employee contribution + employer match) per person is capped at $69,000 in 2024.

  1. No contribution income limit

Unlike an IRA account, for which you won’t be able to contribute if your income is above the contribution limit, you can contribute to your 401k regardless of your income level.


Roth 401K: TAX when contributing; NO TAX when withdrawing.

From the example above, if you are 30 years old and decided to contribute $23,000 to your Roth 401K instead of your traditional 401k, that amount will be included in your 2024 taxable income.

If your account increases annually by 4% every year, after 30 years, when you turn 60 years old, your $23,000 (after tax money) will build up to $74,598 as well. You will not pay tax if you decide to take the $74,598 out of your Roth 401k account.


IRA – Individual Retirement Account

IRA is an individual retirement account. It’s not sponsored by the employer. You can open an IRA account by yourself like your regular brokerage account with a wide variety of investment options which are not available in 401k plans. Some examples are: Single Stock, Mutual funds, ETF, REITs, and Alternative Investment, etc. You can open multiple IRA accounts with multiple brokers and dealers, but your total annual contribution limit is only $7,000 if you are under 50.


With a diverse array of IRA plans, we will be emphasizing two of them today: Traditional IRA and Roth IRA.


Traditional IRA – NO TAX when contributing; TAX when withdrawing.

Traditional IRA is widely utilized by employees that do not have a 401k plan through their employer. This IRA plan is like a Traditional 401k in terms of tax treatment. You can deduct the contribution amount ($7,000 for 2024) from your taxable income. The tax may be deferred until you withdraw money from your IRA account and the withdraw amount may be taxed at ordinary income rate. Furthermore, the allowable income deduction amount may be affected by your income level and whether you and/or your spouse have a 401k plan with the employers.


Roth IRA: TAX when contributing; NO TAX when withdrawing.

In terms of tax treatment, Roth IRA takes a similar approach to Roth 401K. Once you reach 60 and have held your Roth IRA for at least five years, you may withdraw any amount of money from the account completely tax-free. However, the difference between Roth IRA and Roth 401K is that if you make too much money, you may not be allowed to contribute to Roth IRA directly. For example, if you are single and have a modified adjusted gross income (MAGI) equal to or above $161,000, no contribution is allowed.


Planning Considerations:


  1. If you just started your career and your income will increase in the future for sure, you could consider contributing into Roth IRA.
  2. Check with your company HR that if your 401k plan offers company match. Make sure to take full advantage of the company match.
  3. If you have enough cash flow, consider fully funding both your 401k plan and IRAs.
  4. If your income will be higher after you retire, you should consider contributing to Roth 401k. If your current income is high and you expect your income may be lower when you retire, a Traditional 401k could be a viable option.
  5. If you don’t have enough cashflow, a “Waterfalls” method can be considered. First, contribute the amount which may qualify you for the entire employer match amount. Secondly, consider Roth IRA/Traditional IRA contribution. Thirdly, maximize your 401k contribution. In this method, with limited cash flow, you can enjoy both 401k with company match and IRA with investment option flexibility.



Work With a Financial Planner to Navigate Personal Situations


Whether you want to save tax or retirement or build up a family, a retirement plan can have a meaningful impact on your financial life. Make sure you are taking a proactive approach when planning and reviewing your retirement strategy, and you will be more prepared to work toward achieving your financial goals and make the most of your retirement accounts.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal.  Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.