It’s the retirement savings conundrum: choosing the account where you’ll save for your future. If you’re weighing whether to pick an IRA vs. a 401(k), you have 2 strong choices. (But spoiler alert: The answer may be both!)
Here’s what you need to know about the similarities and differences between 401(k)s and IRAs—plus tips to help you decide where to focus your savings.
What is an IRA?
An IRA is a retirement savings option available to anyone with earned income (or whose spouse has earned income). You fund it with contributions directly from your bank account.
What is a 401(k)?
A 401(k) is an employer-sponsored retirement plan where you make contributions through salary deferrals (aka money automatically taken out of your paycheck).
Similarities between IRAs and 401(k)s
Investing tax advantages
401(k)s and IRAs are both powerful tools for building retirement savings. Each allows you to invest contributions so they could potentially grow and compound over time. Contributions made to a 401(k) are generally pre-tax, and contributions to traditional IRAs can be tax-deductible if you fall within the IRS’s income limits. So the account holder may be able to reduce their modified adjusted gross income by contributing to a 401(k) plan or a traditional IRA. What’s more, your investments could grow tax-deferred.
This means that if you earn income from your investments within a 401(k) or IRA, like from dividends or realized capital gains for example, you wouldn't pay taxes on them as long as they remain in the account. This differs from non-tax deferred savings vehicles, like a brokerage account where you'd need to pay taxes on income from investments for the year in which the income occurs.
Traditional and Roth account availability
IRAs and 401(k)s can be traditional or Roth. A traditional retirement account means you can generally deduct what you contribute each year from your taxable income, invest your contributions and have them grow tax-deferred, and then you pay income taxes on what you withdraw in retirement.
Roth retirement accounts, meanwhile, don’t let you deduct your contributions from taxable income for the year in which they’re made. Instead, you make after-tax contributions to a Roth IRA or 401(k) and your contributions and their potential earnings grow tax-free and can be withdrawn federal income tax and penalty free in retirement after age 59½ (the age at which someone can withdraw from a retirement account penalty-free), provided the 5-year aging rule has been met.1
There are some key things to be aware of with traditional and Roth IRAs in particular: to be eligible to contribute, you need to fall within the IRS’s income limits. If you’re a high earner, you might not be able to contribute to a Roth IRA or to deduct your contributions to a traditional IRA, which we’ll discuss more in the section covering the differences between 401(k)s and IRAs.
Withdrawals before retirement
You could face taxes and penalties for early withdrawals from retirement accounts before age 59½. But there are exceptions. Contributions to Roth IRAs can always be withdrawn tax- and penalty-free.
If you qualify for one of the early withdrawal exceptions allowed by the IRS in this bulleted list, then withdrawals before 59½ from a traditional IRA would be penalty-free and withdrawals of earnings from a Roth IRA would be penalty-free. Contributions to a Roth are always tax-and-penalty-free regardless of the age of the account owner.
Exceptions to early withdrawal taxes or penalties include money:
- For qualified educational expenses, like college tuition
- Up to $5,000 for expenses for a birth or adoption
- For medical expenses or to pay for health insurance when you're unemployed
- Up to $10,000 to buy your first home
There are account-specific ways to access retirement funds early penalty-free too, which we cover later.
Withdrawals in retirement
The general rule for penalty-free IRA and 401(k) withdrawals is this: If you’re 59½ or older, you’re good to go. (The catch being that if the 5-year aging rule isn’t met, you might owe taxes on any earnings that are withdrawn from a Roth IRA or Roth-designated employer sponsored plan account).
Required minimum distributions (RMDs)
Traditional IRAs and traditional 401(k)s force you to start withdrawing from your account—whether you need the funds or not—once you reach 73 (age 75 starting in 2033). Those who are still working for the company sponsoring their 401(k) may be able to delay these from the 401(k) until they’ve stopped working, with one exception. If you own 5% or more of the company, you’ll be required to take RMDs as scheduled at the designated age.
Differences between IRAs and 401(k)s
Account availability
Both traditional and Roth IRAs are available at a wide variety of banks and online brokers. Before contributing to either, though, make sure that your income falls within the IRS’s limits for eligibility to contribute to a Roth IRA or to be eligible to deduct contributions for traditional IRAs.
With a 401(k), you aren't eligible to invest unless your employer offers a plan and you meet its qualifications to participate. You also may not have access to a Roth 401(k) unless your employer specifically provides that account type.
Investment options
Because you choose where you open an IRA, you’re able to ensure that your IRA provider has the investment types you want. 401(k) investment offerings, meanwhile, are chosen by your employer, so they may be more limited.
Contribution limits
One of the main differences between IRAs and 401(k)s are contribution limits: 401(k)s have vastly higher limits. For 2024, the 401(k) contribution limit is $23,000 for those under 50 and $30,500 for those 50 or older, who are becoming eligible for catch-up contributions. The 2024 IRA contribution limits are $7,000 for those under 50 and $8,000 for those 50 or older who are eligible for catch-up contributions.
Keep in mind that contributions across all of your traditional or Roth IRAs are aggregated, and the same can be said for contributions across all of your traditional or Roth designated 401(k)s. For example, if you have 2 traditional IRAs and 1 Roth IRA, the maximum you can contribute to all 3 of them in 2024 is $7,000 if you're under 50. In other words, your contribution limit applies across all IRAs as opposed to having a limit per account.
Income limits
How much you earn each year may dictate how much you can contribute to a Roth IRA or how much of your traditional IRA contributions you can deduct from your taxable income each year. Here are Roth IRA income limits and income limits for deducting traditional IRA contributions. Those with incomes over those limits who still want to contribute to a Roth IRA may consider a backdoor Roth IRA, which provides a way for high earners to access a Roth IRA.
401(k)s—even Roth 401(k)s—have no income limits associated with them. If your employer offers the plan and you are eligible to participate, you can contribute to a traditional or Roth 401(k). This may make Roth 401(k)s particularly appealing to high earners looking for easy access to Roth accounts.
Employer contributions
One of the biggest benefits of workplace retirement plans, like 401(k)s, is that they allow your company to contribute to your retirement savings too. This could take the form of profit sharing, where the company contributes a set amount or a percentage to your account regardless of how much you contribute, or a 401(k) match.
A 401(k) match is when your company contributes a certain amount to your 401(k) based on how much you contribute yourself. This might mean, for example, that it contributes a dollar for each dollar you do, up to 3% of your salary. Each company uses its own formula to determine a 401(k) match, so be sure to check your plan documents to see yours.
Employer contributions might come with a vesting period. This means each year you work for the company, you gain ownership of a larger percentage of your employer’s contributions. For instance, you might get 20% more of your employer contributions each year you work for a company until you own 100% after 5 years. Vesting formulas also vary by company.
Employers do not make, or match, contributions to IRAs.
Account-specific early access to funds
In addition to the examples of some of the broad exemptions on penalty-free early access to retirement funds, there are a few account-specific ways to access your money penalty-free before age 59½.
- A Roth IRA lets you withdraw contributions at any time tax- and penalty-free. (The rules are different for earnings on those contributions.)
- Some 401(k) plans allow loans. With a 401(k) loan, you can borrow up to 50% of your account value, up to $50,000, every 12 months. You’ll pay the loan back to your account with interest—generally within 5 years. If you don’t, the IRS will treat the loan as an early distribution. Keep in mind if you leave your company before your loan is paid back, you might have to repay it quickly or else risk it being considered an early withdrawal—and have to pay the taxes and penalties that go with that.
Can you contribute to an IRA and a 401(k)?
Yes, you can contribute to both an IRA and a 401(k), provided you work for an employer that offers a 401(k). If you have a 401(k) with an employer match, you should aim to contribute at least enough to your 401(k) to capture all of that because it’s like free money. Outside of that, you should weigh the pros and cons of IRAs and 401(k)s alongside your financial goals to figure out how much to contribute to each.