Key Differences Between IRA and 401(k) Accounts

Summary

---

WSJ Your Money Briefing

Episode: Key Differences Between IRA and 401(k) Accounts
Date: September 6, 2019
Host: J.R. Whalen
Guest: Laura Saunders, WSJ Tax Reporter

---

Overview

This episode explores the key differences between IRAs (Individual Retirement Accounts) and 401(k) accounts—two of the most widely used retirement savings vehicles in the U.S. Host J.R. Whalen and WSJ tax reporter Laura Saunders discuss practical implications, common pitfalls, and strategies for making smarter choices to avoid unexpected taxes and penalties when drawing or transferring funds.

---

Key Discussion Points & Insights

The Role of IRAs and 401(k)s in Retirement (02:41)

• Pensions are rare: For most savers today, "401s and IRAs, they're pretty much the biggest games in town" (J.R. Whalen, 02:38).
• Interconnectedness: You can often roll your 401(k) into an IRA and, in some cases, roll IRA money into a 401(k).
  Laura Saunders: "Often there's a conduit between IRAs and 401s. You can roll your IRA money into a 401 in some cases, and you can very often roll your 401k money into an IRA." (02:42)

Withdrawing Funds Before Retirement—Key Differences (03:03)

• Exception for buying a first home:
  • IRAs: Up to $10,000 can be withdrawn for a first home purchase; taxes are owed, but the 10% penalty is waived.
  • 401(k)s: The same early withdrawal triggers both regular taxes and a 10% penalty.
  • Key Point: Small differences in withdrawal rules can have big financial impacts.
    Laura Saunders: "It's these subtle differences that really trip people up." (03:37)

Real-life Example of Costly Mistake (03:40)

• A couple, highly educated and well-advised, withdrew funds from a 401(k) for a first home and were hit with an unexpected penalty: Laura Saunders: "It was about $600, but...it raised their tax bill by 65%. And they were pretty upset." (03:47)

Using Retirement Funds for Higher Education (04:13)

• IRAs: Allow penalty-free withdrawals for higher education (tax may still apply).
• 401(k)s: Withdrawals for education are subject to the 10% penalty. Laura Saunders: "In every case, you'll have to pay tax, but the question is, do you have to pay that 10% penalty?" (04:22)

Early Withdrawals Between Ages 55 and 59½ (04:38)

• 401(k) Exception: No penalty is charged on 401(k) withdrawals if you leave your job in this age bracket.
• IRA Restriction: The 10% penalty remains if the same-named withdrawal is taken from an IRA.
• Critical Consideration: Rolling a 401(k) into an IRA after leaving your job can forfeit this penalty exemption. Laura Saunders: "If your employer...wants you to roll your 401 money over into an IRA, then you won't have access to that money without a penalty if you need it for living expenses." (05:00)

Required Minimum Distributions (RMDs) Differences (05:28)

• General Rule: At 70½, most must begin withdrawals.
• 401(k) Exception: If still employed with the plan-holding employer, you may postpone withdrawals.
• IRA Rule: No such postponement possible—withdrawals must begin at 70½ regardless. Laura Saunders: "If you're still working at an employer who allows it, you can postpone that distribution from a 401 plan, but you can't postpone it if it's from an IRA." (05:38)

---

Notable Quotes & Memorable Moments

• On Withdrawal Mistakes:
  “It was about $600, but if you look at it another way, it raised their tax bill by 65%...and they were pretty upset.” (Laura Saunders, 03:47)

• On Subtle Rule Differences:
  "It's these subtle differences that really trip people up." (Laura Saunders, 03:37)

• On the Need for Expert Guidance:
  “It's important to either read the rules carefully or enlist someone who understands them and will give you good advice.” (J.R. Whalen, 04:38)

---

Key Timestamps

• 02:41 – Introduction of why IRAs and 401(k)s are central to retirement planning; account rollovers
• 03:03 – Early withdrawal exception for first-time homebuyers; difference between accounts
• 03:40 – Story of a couple penalized for wrong withdrawal strategy
• 04:13 – Using retirement accounts to pay for higher education
• 04:38 – Early retiree withdrawal penalty differences
• 05:28 – Required distributions: when and for whom
• 05:54 – Reference to Laura’s WSJ column for further details

---

Takeaways

• IRAs and 401(k)s offer similar retirement benefits but differ significantly in rules for withdrawals, penalties, and required distributions.
• Being unaware of these subtle differences can result in costly mistakes—even for financially literate individuals.
• Carefully reading regulations or consulting a knowledgeable advisor is crucial when making major retirement account decisions.

---

For a more detailed breakdown, listeners are encouraged to explore Laura Saunders' columns on WSJ.com.

Transcript

[A]

This podcast is brought to you by relioQuest. Cybercriminals are constantly attacking. They want your data. They want your identity. They want your innovation. RelioQuest fortifies your business with agentic defense AI that detects, contains and eliminates cyber threats in minutes. It helps your security team move faster at the work that matters most to protect the business now, and delivers insights to help them predict what's next. ReliaQuest agentic defense for the enterprise. Learn more at reliaquest.com that's R E L I A Q U E-S-T.com.

[B]

Here's your money briefing. I'm J.R. whalen at the Wall Street Journal in New York. IRAs and 401k retirement accounts sound like they pretty much offer the same kind of investment opportunities for putting money away. But there are actually very distinct differences that can cost you a lot of money if you don't know about them. We'll run down some of those differences in a moment. First, some money and market news you should know the amount workers are producing per hour and their hourly compens rose more quickly in the first half of the year than previously thought. The government says that labor costs were higher in the first two quarters, mainly because hourly compensation was revised upward. It's also a sign that US Corporation profits have begun to weaken, and that could in turn force companies to reduce spending. The latest jump in unit labor costs is part of a longer term shift. Compared with the second quarter of 2018, costs rose 2.6%. That's that's well above the average annual gain of about 1% since 2000, and Harvard, MIT and Yale top the Wall Street Journal and Times Higher Education's college rankings. The rankings emphasize how well a college prepares students for life after graduation, and the rankings are based on 15 factors including academic environment, extracurricular engagement, career opportunities, and return on investment. More broadly, the survey indicates that schools in the west provide more diversity, and while schools in the Northeast are most likely to help students land a great job, check out the full set of rankings on WSJ.com and the WSJ app. 401k accounts and IRAs are both intended for consumers to set aside money for retirement. There are several other things they have in common, but also very significant differences. And not knowing them can cost you dearly. So let's bring in Wall Street Journal tax reporter Laura Saunders to spell it out for us. So Laura, with pensions all but a thing of the past 401s and IRAs, they're pretty much the biggest games in Town.

[C]

Yes, if you're saving for retirement, that's the case. And another thing is that often there's a conduit between IRAs and 401s. You can roll your IRA money into a 401 in some cases, and you can very often roll your 401k money into an IRA.

[B]

Yeah, a big difference between 401s and IRAs comes down to borrowing from the accounts.

[C]

Well, often taking withdrawals ahead of schedule because they're retirement accounts. And so, you know, they're supposed to be for retirement, but there are these exceptions besides death and disabilities. For example, say you need a little bit of extra money to buy your first home. You can take $10,000 up to $10,000 out of an IRA. Now, you' pay your tax, but you don't have to pay a pretty heavy 10% penalty. But if you take the same money out of a 401k, you'll owe both the tax and the penalty. It's these subtle differences that really trip people up.

[B]

And you spoke to a couple who mistakenly. They were tripped up, and they wound up paying money that they didn't want to pay as a result of that.

[C]

Yeah, it was about $600, but if you look at it another way, it raised their tax bill by 65%. So. And they were pretty upset about that. And you know these smart people, he was training to be a doctor and she was a college math teacher, but they were advised by someone at the retirement plan manager that they wouldn't have to pay if they were buying their first home, not the penalty.

[B]

And if somebody wants to tap into a retirement account to pay for higher education costs, you should pull money from

[C]

your IRA, not your 401k. That's exactly right. Same problem there. In every case, you'll have to pay tax, but the question is, do you have to pay that 10% penalty? And in some cases, maybe if you're going back to school, you wouldn't even owe tax at all. But you still have to pay the 10% penalty if you take it from the wrong place.

[B]

Oh, okay. And it's important to either read the rules carefully or enlist someone who understands them and will give you good advice. The differences in rules, for example, can be thorny for people who leave a job between the ages of 55 and 59 and a half.

[C]

Yeah, this is really important because there are a lot of people who are taking early retirement or they're leaving their big corporate job. And there is an exception that says if you take 401k, money out between age 55 and 59 and a half that you don't have to pay the 10% penalty, but if you take it out of an IRA, you do. And so if your employer, say, wants you to roll your 401 money over into an IRA, then you won't have access to that money without a penalty if you need it for living expenses. So these are things to check really carefully.

[B]

And then when it comes to required distributions from the retirement accounts, the rules differ as to when that begins.

[C]

Yes, that's a really interesting one. Pretty much everybody has to take out their retirement money. Has to, starting at about age 70 and a half. The thing is that if you're still working at an employer who allows it, you can postpone that distribution from a 401 plan, but you can't postpone it if it's from an ira.

[B]

All right, It's a lot of information coming at us pretty quickly in this podcast, but check out Laura saunders column on WSJ.com and the WSJ app. And Laura's here in our studio with us. Laura, thanks for coming on the show

[C]

and thank you for having me.

[B]

And that's your money briefing. I'm JR Whalen in New York for the Wall Street Journal.

[A]

This podcast is brought to you by reliaQuest. Cybercriminals are constantly attacking. They want your data, they want your identity, they want your innovation. ReliaQuest fortifies your business with agentic defense AI that detects, contains and eliminates cyber threats in minutes. It helps your security team move faster at the work that matters most to protect the business now and delivers insights to help them predict what's next. ReliaQuest agentic defense for the enterprise. Learn more at reliaquest.com that's R E L I A Q U E-S-T dot com.