There are several major differences between 401(k)s and IRAs. Some of them are rather well-known.
One major difference is investment flexibility. With an employer’s 401(k), you're generally limited to a small "menu" of investment funds. This can be fine if you want to keep your retirement investing on autopilot, but an IRA lets you invest in virtually any stocks, bonds, mutual funds, or exchange-traded funds you want. If you want some of your retirement savings in Nvidia(NASDAQ: NVDA) stock, for example, an IRA can let you do it.
Some differences between 401(k)s and IRAs aren’t quite as well-known but can be very important to understand. One of the biggest differences is how you can use these accounts early.
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Using your retirement savings early
In most cases, you have to leave your 401(k) and IRA savings alone until you reach 59 1/2 years of age. Both have some exceptions, but they are very different.
When it comes to a 401(k), there are a few reasons you’d be allowed to withdraw money early without a penalty. Most notably, there’s the "separation from service" exception, which says that if you are no longer working for the employer who sponsored the plan and you’re older than 55, you can withdraw money.
On the other hand, IRAs have two big exceptions that don’t apply to 401(k)s:
- You can withdraw up to $10,000 from your IRA to use towards a first-time home purchase for you or someone else.
- You can withdraw any amount at any time to use towards higher education expenses. Many parents use IRAs to help pay for college, and simply use what’s left for their own retirement.
Overall, IRAs are more flexible than 401(k)s when it comes to both investment flexibility and early withdrawals. Even if you have a 401(k) or similar plan at work, it could be smart to supplement it with an IRA -- only after you’ve taken full advantage of your employer’s matching contributions, of course.
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