There are several types of tax-advantaged plans that allow you to save for retirement. Some are sponsored by employers, while others are controlled by the individual who opens them. Two examples are IRAs and 401(a) plans, which can both be instrumental in helping you save for retirement. The key difference between the two is that employers sponsor and control 401(a) plans, while the saver who opens an IRA is in control of that account. For more detailed information on IRAs in particular, head on over to our IRA Center. For more on the differences between an IRA and a 401(a), read on.
An IRA, or individual retirement account, is an account you can set up for yourself and control as you see fit. Contributions to a traditional IRA may be tax-deferred: You can deduct your contributions from your taxable income. However, you'll then pay taxes on the money you withdraw during retirement. For 2016, the contribution limit for a traditional IRA is $5,500 if you're under 50, or $6,500 if you're aged 50 or older.
Roth IRAs work a bit differently. With a Roth IRA, you'll pay taxes up front on your contributions, but the withdrawals you make during retirement will be tax-free. The contribution limits for a Roth IRA are the same as those of a traditional IRA.
Once you reach age 59 1/2, you can withdraw funds from your IRA. If you withdraw any money from a traditional IRA before you turn 59 1/2, you'll be hit with a 10% early-withdrawal penalty. With a Roth IRA, you can withdraw your contributions at any time, but if you touch any of the earnings before age 59 1/2, then you'll pay the penalty.
Also known as a money purchase plan, a 401(a) plan is an employer-controlled retirement plan. With a 401(a) plan, your employer sets the rules, such as how much money will be contributed and whether the contributions will be a set dollar amount or a percentage of your salary. Additionally, factors such as eligibility and vesting schedules are determined by the employer. 401(a) plans are popular among government agencies, educational institutions, and non-profit organizations.
Both employers and employees can contribute to a 401(a) plan. Contributions to 401(a) plans are tax-deferred, which means you'll pay taxes only once you start taking money out of your plan. For 2016, the contribution limit for a 401(a) plan is $53,000. You can make also make after-tax contributions to your 401(a) plan, but you're limited to 25% of your salary.
As with an IRA, you can begin making withdrawals from your 401(a) plan once you reach 59 1/2, but if you take out funds before that, you'll face a 10% early-withdrawal penalty. Funds are typically withdrawn from a 401(a) plan through a lump-sum payment, a rollover to another qualified plan, or an annuity. Some employers set up 401(a) plans in the hopes of retaining employees on a long-term basis. If you leave your employer before you reach retirement age, you have the option to roll your 401(a) funds into an IRA.
IRAs vs. 401(a) plans
The primary difference between an IRA and a 401(a) is that you can't open a 401(a) plan on your own; your employer must sponsor and govern it. 401(a) plans also have a distinct disadvantage in that they're typically subject to employer-dictated vesting schedules. This means that if you leave your employer before you're fully vested in your 401(a) plan, them you may have to forfeit a percentage, or all, of your employer's contributions. It is possible to have both an IRA and a 401(a) plan at the same time. However, if you have a 401(a) plan, your immediate tax benefits for your traditional IRA contribution may be phased out depending on your adjusted gross income.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at firstname.lastname@example.org. Thanks -- and Fool on!