IRAs and 401ks are the two most popular retirement plans in the United States. Despite some similarities between them there are differences. Understanding the differences and limitations to these vehicles is vital to retirement planning.

What is a 401K
A 401K is a retirement plan designed to take advantage of section 401K of the federal income tax code. This section allows persons to save money for retirement in a tax deferred account. It also allows employers to make tax deductible contributions to such an account. The big advantage to a 401K is that an employer can match employee contributions or make additional contributions to the funds each year. This can effectively increase the amount a person saves for retirement.

A 401K is an account into which both the employer and the employee can make contributions. The difference between a 401K and an IRA is that the 401K is maintained by the employer and will have to be rolled over if you change jobs.

What is an IRA
An IRA is an individual retirement account a tax deferred vehicle into which a person can contributed a certain amount of money for retirement savings and investment each year. The difference between an IRA and a 401K is that you set up and administer the IRA yourself so it stays with you. There are certain kinds of IRAs such as SEP IRAs that can be set up by employers for employees.

Persons who change jobs will usually roll the funds that they have in a 401K over into an IRA. This keeps the funds tax deferred, which means they can be deducted from your taxable income until they are withdrawn. A major limitation to both 401Ks and IRAs is that most people will have to pay a 10% income tax penalty if they withdraw funds before age 59.

Persons can chose between a number of different IRAs including a Roth IRA which is not tax deferred but does give a person an opportunity to contribute more money. A major disadvantage to both IRAs and 401Ks is that individuals can only contribute around $2,000 a year to one under normal circumstances.

Investment through IRA and 401ks
A person who invests through a 401K will usually have a limited number of choices provided by the employer usually mutual funds or annuities. IRAs can give you a wide variety of retirement choices. Many people open IRAs through brokerages and investment houses in order to get a greater choice in retirement investing opportunities. Almost all popular investments are available through IRAs including annuities, stocks, mutual funds, ETFs and even commodities like gold.

A Third Alternative You May Not Be Aware Of
There is a third alternative to IRAs and 401Ks that you may not be aware of annuities. Like 401ks and IRAs, annuities are tax deferred but there is no limit on the funds you can invest in one. You can even roll funds in an IRA or 401k over into one. This can enable a person to greatly increase the amount of tax deferred funds invested for retirement.

Persons who take advantage of indexed annuities can have many of the same investment opportunities offered IRAs and 401ks. They also enjoy an additional layer of protection because annuities are an insured investment.