Lesser-Known Differences Between IRAs and 401(k) Plans

Comprising approximately one-third of household wealth in the United States, the retirement market is massive. Of the $47 trillion currently held in retirement assets, the majority are within IRAs ($18 trillion) and 401(k) plans ($10 trillion).* This is not surprising since the 401(k) has been the dominant employer retirement plan for decades, with rollovers out of plans driving growth in IRAs. For plan participants and IRA owners it’s important to understand how these two retirement savings vehicles differ. Beyond the obvious differences such as contribution limits, ability to take loans and eligibility requirements, here are some other, lesser-known differences many savers may not be aware of.

* Investment Company Institute, June 2026.

Avoiding Early Withdrawal Penalties

Withdrawal penalties are one of the most confusing areas given the proliferation of more exceptions over the past few years combined with differences in how they apply to IRAs and 401(k) plans. Here are the exceptions that apply to both:

• Death
• Disability
• Attain age 59 ½
• Substantially equal periodic payments (i.e. 72(t) distributions)
• Qualified birth/adoption expenses of up to $5,000
• Qualified military reservist distribution
• Unreimbursed medical expenses in excess of 7.5%
• Emergency withdrawal of up to $1,000 annually
• Terminal illness
• Domestic abuse

However, there are some key differences in how early withdrawal penalty exceptions apply:

Source: IRS, 2026. Exceptions for 401(k) accounts also generally apply to 403(b) and 457 accounts. There may be other, less common situations for avoiding the 10% early withdrawal penalty on a distribution. Examples include an IRS levy, a corrective plan distribution, or a dividend pass-through from an ESOP. For more information, consult IRS publication 590-B, Distributions for Individual Retirement Arrangements; IRS Topic 558, Additional Tax on Early Distributions from Retirement Plans Other Than IRAs; or IRS Topic 557, Additional Tax on Early Distributions from Traditional and Roth IRAs.

Separating from Service and the “Rule of 55”

For some 401(k) participants leaving their job, this is an important provision to know. If you leave your job during the calendar year you reach age 55, the 10% early withdrawal penalty does not apply on a distribution from that plan. This feature only applies to the employer plan from which you are separating from service. Additionally, if the funds are rolled into an IRA, this option is forfeited. For some in this situation considering a rollover to an IRA or transfer to another employer plan, it may make sense to leave the funds in the former employer plan until reaching age 59 ½, when penalty-free withdrawals apply to everyone. Not all employer retirement plans offer this provision, so it’s important to review the Summary Plan Description for specific plan rules.

Option to Defer Required Distributions

While required minimum distributions begin at age 73 (or age 75 if you were born in 1960 or later), there is a provision within employer plans like 401(k)s—referred to as the “still working exception”—which allows these to be delayed. The option only applies to the current employer plan and is not allowed for those who own 5% or more of the company. Additionally, the plan must explicitly allow this. Once you separate from service, required distributions must begin.

After-Tax Savings and Roth Conversions

For IRA owners who hold a mix of pre-tax and after-tax (i.e. non-deductible contributions), tax reporting on a Roth IRA conversion can be a bit tricky due to the pro-rata rule. This means that a partial conversion will consist of a pro-rata portion of pre-tax and after-tax funds held in all your IRAs (including SEP and SIMPLE). That is, there is no way to convert only after-tax funds and avoid taxes on a Roth IRA conversion. However, this rule works differently within a 401(k) plan (subject to specific plan rules). 401(k) plans may allow employee contributions in three different account types: pre-tax, Roth, and after-tax. Both pre-tax and after-tax funds are tracked separately and may be converted to a Roth account without being held in aggregate, thus the pro-rata rule would not apply across the pre-tax and after-tax accounts.

The after-tax account, however, may have contributions and earnings in which only the earnings portion is taxable upon distribution or conversion. Conversions of after-tax amounts are pro-rated across the contributions and earnings within the after-tax account balance when completing an in-plan conversion. This is sometimes referred to as the “mega backdoor Roth strategy.”

There is a special provision for eligible rollovers of the after-tax balance from a 401(k) which allows the contributions and earnings portion of the account to be split and rolled over separately to a Traditional and Roth IRA. The contribution portion can be rolled directly into a Roth IRA without tax liability, and the earnings portion can be rolled into a Traditional IRA to avoid immediate tax. If the earnings portion is rolled into a Roth IRA, this would trigger a taxable event.

Beneficiary Distribution Rules

401(k)s and IRAs are essentially subject to the same beneficiary rules, which can be complex. The SECURE Act of 2019 (Setting Every Community Up for Retirement Enhancement) created new classifications of beneficiaries in determining how rapidly distributions are to be taken from retirement accounts. Most non-spouse beneficiaries are now required to empty inherited retirement accounts within 10 years of the death of the account owner, which has sparked new conversations around planning for legacy and tax considerations.

One important note is that employer plans like 401(k)s are often more restrictive than what the law allows and therefore may disallow the use of certain types of beneficiaries such as trusts or charities. An employer plan may also have more restrictive rules regarding the allowable schedule of distributions, and in some cases may force beneficiaries to take a lump-sum distribution after the death of the original account owner. A named beneficiary may be allowed to roll an inherited employer 401(k) plan account into an inherited IRA, so it is important to make sure that the 401(k) has up-to-date beneficiaries on file with any primary and contingent beneficiaries listed.

Seek Guidance

Properly navigating these rules around retirement accounts may make a meaningful difference in avoiding costly mistakes while managing your retirement savings. Consider working with a qualified advisor or tax professional regarding your specific situation.