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401k's, IRAs and Roth's, what do they all mean?

Updated: Feb 7

If your a US citizen or US expat, the sheer number of retirement and savings options out there can be overwhelming at times. With members of the public vying for each side as the one stop solution. However as we discuss below, each of these retirement vehicles have their own benefits and drawbacks associated and sometimes may not be the best options available.

What is a 401(k)?

A 401(k) is a retirement savings plan sponsored by an employer. It lets workers save and invest a piece of their paycheck before taxes are taken out. Taxes aren’t paid until the money is withdrawn from the account.

While a 401(k)can help you save, it has plenty of restrictions and caveats. In most cases, you can’t tap into your employer’s contributions immediately. Vesting is the amount of time you must work for your company before gaining access to its payments to your 401(k). (Your payments, on the other hand, vest immediately.) It is an insurance against employees leaving early. On top of that, there are complex rules about when you can withdraw your money and costly penalties for pulling funds out before retirement age.

Who is eligible for a 401(k)?

  • You must be 21 years of age

  • You must be a full-time employee, who has served up to a year of service.

  • If you meet this criteria, your employer must allow you to participate in a company-matching qualified retirement plan.

  • Not all employers make employees wait a full year before enrolling (the longest allowable time by law).

What are 401(k) contribution limits?

401(k) contributions offer more fiscal freedom than an IRA. The IRS updated the contribution limits for 401(k) plans in 2024, increasing the employee contribution from $22,500 to $23,000. Other important increases that went into effect for 2024: The catch-up contribution rose to $7,500.

401(k) distributions tax

Contributions to a 401(k) are pre-tax, which means you don't pay taxes until you withdraw money from the plan. This may be attractive for those who expect to be in a lower tax bracket during retirement than during their working years. In addition, your contributions have the potential to grow on a tax-deferred basis.

As with IRAs, non qualified withdrawals from a 401(k) before the age of 59½ are subject to a 10% Federal income tax penalty, unless a qualified exception applies. Some employers may also offer a Roth 401(k) option, which allows workers to make Roth IRA-type contributions to their 401(k) plan without the income restrictions and lower contribution limits that apply to Roth IRAs. The contribution limits are the same as for traditional 401(k)s, but salary deferrals to Roth 401(k)s are not tax deductible. Qualified distributions are tax free.

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