I need a SIMPLE definition of a 401K. How does it compare to a traditional IRA?

Hi lucyfur-ga:

Thanks for your Question!

You asked for a simple definition of a 401-k, and how it compares to
an Individual Retirement Account (IRA). First, here are the
'dictionary' definitions:

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a retirement savings plan that is funded by employee contributions and
(often) matching contributions from the employer; contributions are
made from your salary before taxes and the funds grow tax-free until
they are withdrawn at which point they can be converted into and IRA;
funds can be transfered if you change employers and you can (to some
extent) manage the investments yourself

source: http://www.cogsci.princeton.edu/cgi-bin/webwn

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An IRA provides individuals an opportunity to save for retirement on a
tax-deferred basis. Individuals may contribute up to $2,000 per year
in an individual account; for spousal accounts the limits are $4,000
if both spouses work and $2,250 if one spouse works. The amount that
is tax deductible varies according to an individual's pension
coverage, income tax filing status, and adjusted gross income. Account
balances distributed from one IRA or from a qualified retirement plan
may be rolled over to another IRA.

source: http://www.asec.org/terms.htm

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So, in simpler terms, a 401-k is a retirement savings method that
allows an employee to redirect pre-tax income directly into it, with
some employers optionally contributing to the 401-k as well for the
benefit of the employee. Any income that is directed to a 401-k
account is not subject to income tax until that money is withdrawn
(such as after retirement). The 401-k is managed by the company or a
party hired by the company.

An individual retirement account is a retirement savings method where
any individual can choose to deposit up to $2000/yr, and depending on
the rest of their financial situation, generate income tax savings by
treating the contribution as pre-tax income. If they are able to do
this, then the tax on the contribution is deferred, again until it is
withdrawn from the account. An IRA is managed by the investor, usually
with the assistance of their financial advisor (bank, agent).

The biggest difference is that a 401-k is arranged through an
employer, whereas an IRA can be set up by anyone through a wide
variety of financial institutions.

I hope that this is simple enough!

Regards,

aht-ga
Google Answers Researcher

Good answer and about as simple as possible on this subject. Thanks.