5 Key Differences Between IRAs and Employer-Sponsored Retirement Plans
By Jeffrey Levine, IRA Technical Expert
Follow on Twitter: @IRAGuru4EdSlott
A recent survey by TIAA-CREF revealed some startling data. Perhaps most troubling is the fact that the average American seems to be spending more time planning where they’re going to go eat than they do planning for retirement. 25% of those surveyed said they spend at least two hours selecting a restaurant for a special occasion, while just 15% – yes 15% – said they spent at least the same two hours planning what to do with their IRAs.
Also startling was the fact that over one-third of those surveyed either did not know what an IRA is or the difference between an IRA and an employer-sponsored plan. That’s not good news and needs to be fixed. So, with that in mind, below are 5 key differences between IRAs and employer-sponsored retirement plans.
- Different Contribution Limits
In 2014, the maximum IRA contribution is $5,500. If you’re 50 or older by the end of the year, you can make an additional “catch-up contribution” of $1,000, bringing your total 2014 IRA contribution to $6,500. Employer-sponsored plans, however, generally allow you to contribute much larger amounts. For instance, in 2014, the salary deferral limit for 401(k) and similar plans is $17,500. If you’re 50 or older by the end of the year, you can make an additional catch-up contribution of $5,500, bringing your total 2014 salary deferral amount to $23,000.
- You Don’t Need Your Employers Help To Establish An IRA
If you’re eligible to contribute to an IRA in 2014 (you have “compensation,” like earned income, and you’re not age 70 ½), than there’s nothing that can stop you from making an IRA contribution … other than yourself. If you already have an IRA, you can make your contribution there. If you don’t have an IRA, or would simply like to make your contribution to a different account, you can establish a new IRA and make your contribution there. Employer-sponsored plans, however, don’t work the same way. If you want to defer money into a 401(k), but your employer doesn’t offer one, that’s just too bad. And if your employer does, they will generally be the one who determines to what financial institution your salary deferrals go to, not you.
- There’s No “Still Working Exception” For IRAs
If you have a traditional IRA (including a SEP IRA or a SIMPLE IRA), you must begin taking required minimum distributions (RMDs) in the year you turn age 70 ½, even if you’re still working. On the other hand, if you have a 401(k) or similar plan, and you’re still working for the company that sponsors the plan, you may be able to defer taking RMDs from that plan as long as you’re still working. As long as the plan allows for this feature, commonly known as the “still working exception,” and you’re not more than a 5% owner of the company, you can delay RMDs until the year you retire.
- You Can Always Access Your IRA Funds
If you have retirement money in an IRA, you’re able to access that money at any time – at least according to the tax code. That doesn’t mean there wouldn’t be a penalty if you withdrew funds prior to age 59 ½, but you’re at least able to get to your retirement savings, if need be. (Note: You’re retirement savings should generally be one of the last, if not the last place, you turn to for cash.) On the other hand, if you make salary deferrals to a 401(k) or similar plan, you’re generally not able to access those funds if you’re still working and you’re under age 59 ½. Your plan might even restrict your access further, preventing you from accessing money until a particular event, such as separation of service.
- You Can’t Borrow From Your IRA
When it comes to retirement accounts, there are small mistakes, and then there are the gigantic mistakes that seem to happen more often. One of those gigantic mistakes is called a “prohibited transaction.” That’s a fancy term for a retirement account no-no, and it comes with potentially disastrous tax consequences. One type of prohibited transaction is borrowing from your own IRA. It simply can’t be done. In fact, if you had a $1 million IRA and borrowed just one dollar, your entire IRA would be deemed distributed as of January 1 of the year you made the transaction. Plans, on the other hand, have different rules. IF – and this is a big if – your plan offers such a feature, you may be able to borrow up to $50,000 of your plan money, depending on your plan balance. This would not be considered a prohibited transaction and, as long as you timely pay back your loan, you can generally avoid serious tax ramifications.