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401(k)
A 401(k) is a retirement savings plan offered by many U.S. employers that allows employees to save and invest part of their paycheck before taxes are taken out. Contributions are deducted directly from the employee’s paycheck and deposited into their 401(k) account, often with investment options like mutual funds, stocks, or bonds.
Employers may offer a “match,” contributing additional funds up to a certain percentage, which boosts the employee’s savings. The money grows tax-deferred, meaning taxes are only paid when funds are withdrawn in retirement, usually after age 59½. Withdrawing funds earlier can result in taxes and penalties.
There are two main types of 401(k)s: Traditional and Roth. In a Traditional 401(k), contributions are made pre-tax, reducing taxable income now, while a Roth 401(k) involves after-tax contributions but allows tax-free withdrawals in retirement.
Individual Retirement Accounts
An Individual Retirement Account (IRA) is a tax-advantaged savings account designed to help individuals save for retirement. There are two main types: Traditional and Roth IRAs. Contributions to a Traditional IRA are often tax-deductible, meaning they can lower taxable income in the year of the contribution. Earnings grow tax-deferred, and withdrawals in retirement are taxed as ordinary income. Roth IRA contributions, however, are made with after-tax income, so they don’t offer an upfront tax break. However, earnings grow tax-free, and qualified withdrawals in retirement (typically after age 59½) are also tax-free.
Both IRAs have annual contribution limits, which for 2025 is $7,000, with an additional $1,000 catch-up contribution allowed for those aged 50 or older. The SECURE 2.0 Act of 2022 introduced cost-of-living adjustments to IRA catch-up limits for those over 50, so they may increase in the future.
IRAs are subject to certain eligibility rules and income phase-outs for deductions (Traditional IRA) or contributions (Roth IRA) based on income and filing status. They provide a flexible way for individuals to save for retirement independently of employer-sponsored retirement plans.
Retirement Savings Contributions Credit (Saver’s Credit)
The Retirement Savings Contributions Credit, or Saver’s Credit, is a tax credit designed to encourage low- to moderate-income individuals and couples to save for retirement. It provides a credit of up to 50% of eligible contributions made to retirement accounts, like a 401(k), IRA, or other qualified retirement plans. The credit rate—50%, 20%, or 10%—depends on the taxpayer’s income and filing status, with lower incomes qualifying for a higher percentage.
For 2025, the Saver’s Credit income limits are $79,000 for married couples filing jointly, $59,250 for heads of household, and $39,500 for singles. This credit can reduce taxes owed, but it’s nonrefundable, meaning it can reduce your tax bill to zero but won’t generate a refund. Eligible taxpayers must be 18 or older, not full-time students, and not claimed as dependents on another person’s return.
SIMPLE IRA and 401(K) Plans
SIMPLE IRA (Savings Incentive Match Plan for Employees Individual Retirement Account) is a retirement savings plan designed for small businesses with 100 or fewer employees. It allows employees to contribute a portion of their salary, with employers required to match contributions up to 3% or provide a flat 2% for all eligible employees. SIMPLE IRAs have lower administrative burdens and no annual filing requirements, making them easy to manage.
SIMPLE 401(k) is a similar retirement plan tailored for small businesses, allowing employees to save for retirement while also offering higher contribution limits than SIMPLE IRAs. Employees can contribute up to $20,500 (for 2024), plus a catch-up contribution of $3,500 if aged 50 or older. Employers must match employee contributions or make a fixed contribution. SIMPLE 401(k)s allow for loans, providing more flexibility in accessing funds, while requiring annual compliance and reporting.
Both plans offer tax advantages, encouraging retirement savings. The key differences lie in contribution limits, administrative requirements, and withdrawal options, with SIMPLE 401(k) plans providing more features at the cost of increased compliance. Here’s a comparison of their main features:
Contribution Limits
- SIMPLE IRA: In 2024, employees can contribute up to $16,000, plus a $3,500 catch-up for those 50 and older.
- SIMPLE 401(k): Contribution limits are the same as SIMPLE IRAs, but with additional flexibility for employer contributions.
Employer Contributions
Both plans require employer contributions, but in slightly different forms:
- SIMPLE IRA: Employers must either match employee contributions up to 3% of their compensation or contribute a flat 2% for all eligible employees.
- SIMPLE 401(k): Employer contributions follow the same rules as the SIMPLE IRA, but the employer match can be lower in some years without IRS penalties.
Withdrawals and Penalties
- SIMPLE IRA: Withdrawals before age 59½ are subject to a 25% penalty if made within the first two years of participation.
- SIMPLE 401(k): Early withdrawals may incur a 10% penalty, but loans are allowed, which is not an option in SIMPLE IRAs.
Compliance Requirements
- SIMPLE IRA: Has fewer administrative requirements and avoids annual filings.
- SIMPLE 401(k): Requires additional compliance, including annual reporting, but offers more flexibility in terms of employee contributions and loans.
Overall, the SIMPLE IRA is easier to manage, while the SIMPLE 401(k) provides additional options for employees but involves more administrative effort.