IRA Vs. 401(k): Key Differences And How To Choose

The best time to start saving for retirement is as soon as possible. But which retirement vehicle should you choose? Among the most common ones are 401(k)s and IRAs. 

The key difference between a 401(k) and an IRA is that employers provide 401(k)s while individuals open IRAs through banks, credit unions or other financial platforms. How you can invest money in each account depends on factors such as the account’s contribution limit for the year as well as your employment status and annual income.

Let’s dive deeper into the key differences between IRAs and 401(k)s, along with the pros and cons of IRAs and 401(k)s.

Pros And Cons Of 401(k)s

It’s generally best to wait until at least age 59 1/2 to withdraw funds from your 401(k) account (the same goes for IRAs). If you wait until you reach the required age to withdraw funds, you can access your money without paying a penalty, which is usually around 10%. 

Here are some of the top pros and cons of using a 401(k) as part of your overall retirement planning.

What Is An IRA?

An individual retirement account (IRA) is a tax-advantaged investment portfolio you can use to save for retirement. Like a 401(k), you are incentivized to keep any contributions in your IRA until age 59 ½. IRAs are set up by an individual rather than an employer, which means you have flexibility in the financial institution you choose and the investments they offer. They can be a great option if you’re an entrepreneur or your employer doesn’t provide a work-sponsored retirement plan. 

Anyone with earned income can open and contribute to an IRA, subject to income limits. This is true even if you participate in your employer’s 401(k) plan (you can participate in both).

Most banks, brokerages and investment firms offer IRA accounts. While most IRAs offer similar types of investments, options vary by provider. If you want to invest in a specific type of asset, make sure that your provider supports it. An IRA can be a great way to save for retirement while also possibly getting a tax break.

Types Of IRAs

There are two main types of IRAs – here’s how they compare:

• Traditional IRA: With a traditional IRA, your contributions are tax-deductible and use pretax dollars, meaning you won’t pay taxes on those funds now but you will in retirement. Contributions and earnings grow tax-deferred. When you withdraw, the amount is added to your yearly taxable income.
• Roth IRA: With a Roth IRA, contributions come from taxed income, also known as post-tax dollars. They’re not tax-deductible, but you won’t pay taxes on withdrawals since you paid them upfront. Contributions and earnings grow tax-free.

In 2024, the contribution limit for a Traditional or Roth IRA is $7,000. That said, there are many other types of IRAs, particularly for small business owners and entrepreneurs that offer significantly higher contribution limits worth considering. For example, a Simplified Employee Pension (SEP) IRA has a contribution limit of $69,000 for 2024.

Pros And Cons Of IRAs

An IRA can be a great vehicle to help you reach your retirement goals. With an IRA, you typically have more control over your money and how it’s invested than you do with a 401(k). 

Here are some of the biggest pros and cons of using an IRA.

IRAs and 401(k)s are retirement savings plans with tax incentives. Both plans give you the option to make consistent contributions toward your future, but a few distinctions put these plans in different categories. 

The biggest differences between a 401(k) and an IRA is that you open a 401(k) through your employer and the contribution limits are different. With an IRA, you also have the autonomy to contribute and invest how and when you see fit.

Keep in mind if you have access to a 401(k) that you can contribute to both a 401(k) and an IRA in the same year to take advantage of the tax benefits offered by both type of accounts.

Here are a few key differences between an IRA and a 401(k) plan to be aware of:

Here’s a slightly more in-depth breakdown of the contribution limits, plan eligibility, contribution sources and investment flexibility for an IRA versus a 401(k).

• Contribution limits: Both an IRA and a 401(k) plan come with contribution limits set by the IRS. A 401(k) has higher contribution limits than an IRA. In 2024, the IRS limit for individual 401(k) contributions is $23,000, while the IRA contribution limit is $7,000.
• Plan eligibility: To open a 401(k) plan, you must work for an employer that offers this option as a retirement plan. If you don’t work for an employer offering a 401(k) plan, you can’t contribute to one on your own. In contrast, anyone who has earned income and falls within IRS income guidelines can get an IRA.
• Contribution sources: Employers most often automatically withhold 401(k) contributions from your paycheck. Depending on your plan, you may also be able to make direct contributions. With an IRA, you generally contribute money directly to your broker from a checking account, for example.
• Investment flexibility: 401(k) plan investment options are set by employers and the companies that run the plan. This means you may be limited in what you can invest in. You may not be able to choose your exact preferred investment. With an IRA, you’ll likely have a wider array of investment options, depending on the bank or brokerage you opened your account with.

401(k) Vs. IRA: How To Choose

If you’re trying to decide between a 401(k) and IRA, the good news is that you don’t have to make this choice. You can strategically invest in both, depending on your employer, your income and each account’s contribution limits.

If your workplace offers a 401(k) and an employer match, take advantage of this option. If your employer doesn’t offer a 401(k) or you simply want to grow your retirement savings, consider opening an IRA.

401(k) Vs. IRA FAQs

Let’s look at a few frequently asked questions about IRAs and 401(k)s. 

Is a 401(k) considered an IRA?

No, a 401(k) isn’t considered an IRA – these are two separate types of retirement savings accounts. Although both an IRA and a 401(k) plan allow you to save for retirement, they come with some key differences. Most people are eligible to open an IRA with their choice of bank or investment brokerage. On the other hand, you must open a 401(k) account through an employer.

Is an IRA better than a 401(k)?

There’s no simple answer to whether a 401(k) or an IRA is better. The plan that will work best for you depends on your personal finances and financial goals. If your employer offers a 401(k) plan, especially one with contribution matching, you may want to take advantage of it to gain extra funds. You can also have both an IRA and 401(k).

If your employer doesn't offer a retirement plan, an IRA can be a good option. It can also make sense to open an IRA if you want more control over your retirement savings.

Can I roll a 401(k) into an IRA?

It depends. If you have a Traditional IRA (but not a Roth IRA), you can usually roll a 401(k) from a previous employer into an IRA because they both utilize pretax contributions. You could not roll a 401(k) into a Roth IRA because the former uses pretax dollars, while the latter uses post-tax dollars to fund the respective accounts.

Can I roll an IRA into a 401(k)?

Whether you can roll an IRA into a 401(k) depends on the type of 401(k) plan you have. Check with your plan distributor for more information on their policies.

The Bottom Line

IRAs and 401(k) plans are both accounts designed to help you save for retirement. While they share a common goal, they differ in contribution limits and the flexibility you have in choosing your investments.

Not all employers offer 401(k) plans, which is a reason you might consider an IRA. As long as you have earned income, you can open an IRA to start saving for retirement.

If you have multiple retirement accounts and you want to keep track of them, consider signing up for Rocket Money℠ for help with monitoring your investments.