IRA vs. 401(k): The Best Way to Use Each Account

Written by Dayana Yochim, Andrea Coombes
Edited by Carolyn Kimball

October 03, 2024

The best way to get the maximum mileage out of your retirement savings dollars is to contribute the fully allowable amount to both IRAs and 401(k)s each year.

In 2024, the IRS allows those who are eligible to contribute to both a 401(k) and an IRA to save up to $30,000. If you’re 50 or older, the contribution limit is even higher if you want to max out both accounts — $38,500.

But what if you can’t afford to peel off that much money from your present-day paycheck to provide for your future? That’s the reality for a lot of people, which brings us back to the “which is better, an IRA or a 401(k)?” question. The answer for those without the means to max out both accounts is, “That depends.”

Both IRAs and 401(k)s are valuable tools in your retirement savings strategy. But there are notable differences in how they work. In this article we’ll help you compare the differences between IRAs and 401(k)s to choose the best retirement savings account.

What are IRAs and 401(k)s?

An IRA is an individual retirement account, set up and funded at a financial institution by an individual. For more details on IRAs, see the aptly titled What Is an IRA?

A 401(k) is an employer-sponsored retirement plan that’s offered by a company to its employees, allowing workers to automatically divert a portion of each paycheck into the plan. 403(b)s and 457s are similar plans for teachers, nonprofit employees and government workers. Get the lowdown on this seminal workplace retirement account in What is a 401(k)?

3 ways IRAs and 401(k)s are alike

Before we start taking bets on which type of account would triumph in a no-holds-barred cage match, let’s look at the features IRAs and 401(k)s have in common.

1. Both IRAs and 401(k)s shield your investments from income taxes … for decades.

Money within IRAs and 401(k)s has protected status from the IRS. That’s great news, considering the investments you hold within these accounts will be increasing in value for years. That investment growth remains untaxed for as long as those dollars remain in the safe confines of an IRA or 401(k).

Taxes enter the equation when you start withdrawing money (aka “take distributions”). Depending on the type of account in which the money has been kept, you’ll either owe income taxes on the amount you take out, or you won’t. This provides a smooth segue into the next thing that IRAs and 401(k)s have in common…

2. Both IRAs and 401(k)s come in traditional and Roth versions.

The OGs of retirement savings plans are traditional IRAs and traditional 401(k)s. The Roth IRA (named after one of the senators who introduced the bill to Congress) came onto the retirement savings scene in 1998, providing savers a choice in how and when they get a tax break. In 2006 Congress paved the way for employers to include a Roth election within their 401(k) and 403(b) plans.

Money within both Roth and traditional plans is not taxed. The difference between these two types of accounts is how the IRS treats your dollars before they go in and when they come out:

• Traditional IRAs and 401(k)s both give you an immediate tax break on your contributions. Each dollar you save in these types of accounts lowers your current taxable income in the year you stash it away. Taxes come back into play when you start making withdrawals. The IRS considers this money income, so you’ll owe income taxes on the amounts you take out. In technical terms, traditional IRAs and traditional 401(k)s provide tax-deferred investment growth.
• Roth IRAs and Roth 401(k)s provide tax-free withdrawals in retirement but no upfront tax savings. When you contribute to a Roth account you’re not allowed to exclude that contribution from the income you report to the IRS on your tax return. (Translation: No upfront tax break.) But because you’ve already paid the IRS, you won’t owe any taxes on your withdrawals. If you want to wow your friends at cocktail parties, you can brag about getting tax-free investment growth in a Roth.

3. Both IRAs and 401(k)s let you access money in an emergency.

The IRS discourages dipping into retirement savings accounts before you reach the age of 59½. The guardrails it uses are taxes and early withdrawal penalty fees. That said, even the government recognizes that emergencies happen. Depending on the need — whether it’s related to a hardship (such as medical costs), or simply the desire for an early distribution (to cover higher education costs or a first-time home purchase) — you may be able to avoid the 10% early withdrawal penalty. (See this IRS chart on exceptions to the 10% additional tax on early distributions. Note that the exceptions vary for IRAs vs. 401(k)s.)

Note: If you make a qualified early withdrawal, the only thing that’s potentially waived is the 10% early withdrawal penalty for accessing the money before age 59½. You will pay income taxes on the amount you withdraw unless the money consists solely of the contributions you made to a Roth IRA account.

Note on the above note, because, yeah, this stuff can be confusing: With a Roth IRA, you can always withdraw your contributions, without owing taxes or a penalty, because that’s money you’ve already paid income tax on. In addition, there are “qualified” early distributions from a Roth IRA that let you withdraw your investment earnings while avoiding the 10% early withdrawal penalty, if a) you have owned the Roth IRA for at least five years, and b) the money is used for a qualifying purpose (e.g., a first-time home purchase; it’s needed because of a disability; or it’s made to a beneficiary after your death). But, if you touch your Roth 401(k) contributions early for any reason besides those listed on this IRS page, you’ll pay the 10% penalty.

And one final note, as long as we’re on the topic: Not all 401(k) plans allow hardship distributions. And even those that do are allowed to set the criteria for hardships, which means a plan may allow you to take a withdrawal for funeral or medical expenses but not education costs or the purchase of a principal residence. And you may still owe the 10% early withdrawal penalty (check out this IRS table to see which withdrawals avoid the 10% penalty). Some 401(k) plans allow participants to take loans — more on that below — while IRAs do not allow loans.

Key takeaway: Before making an early withdrawal from your IRA or 401(k), look up what that particular plan’s rules are so you don’t get any unwelcome surprises.

IRA vs. 401(k) at a glance

For those who want to skip right to the highlight reel, here’s a quick side-by-side comparison of IRAs and 401(k)s. Read on for the more detailed color commentary on the pros and cons of each type of account below and why these differences may matter to you.

401(k) vs. IRA comparison

*Contributions to an IRA for 2023 can be made up to April 15, 2024.
Source: IRS.gov

Going from one to the other

There's one other type of IRA you may hear about: the rollover IRA. A rollover IRA is used, for example, when you want to move money from a 401(k) at a former job into a new account which you can control.

IRA vs. 401(k) pros and cons

We’ll start by saying something nice about each type of retirement account, starting with IRAs:

The best things about IRAs are accessibility and freedom of choice: Anyone with earned income can open and fund an account (though Roth IRAs do have income limits). The ability to choose a version of an IRA — Roth, traditional, spousal, SEP, etc. — that best suits your situation is also a major plus, as is unfettered access to an array of investments at whatever financial institution you fancy.

And now it’s 401(k)s moment in the spotlight:

Simply by virtue of size — the IRS allows much higher contributions in a workplace plan than an IRA — 401(k)s are like IRAs on steroids. They provide more cover for a greater portion of your investments to grow free from the IRS’s reach, and, as a result, a bigger upfront or back-end tax break, depending on which type of 401(k) you choose.

But perhaps the best feature of 401(k) plans is company-supplemented savings. In 2022 nearly half of the defined-contribution plans managed by Vanguard offered an "employer match" (which is based on how much an employee contributes to their own account). Ten percent of plans kicked in money without requiring any employee contribution, and 36% of plans offered both matching and nonmatching contributions. All told, 95% of plans contributed additional retirement savings to workers' accounts.

As much as we hate to talk trash (except on the pickleball court), we’d be remiss if we skipped over the potential drawbacks of IRAs and 401(k) plans:

IRAs, we’d like a word:

One of the biggest downsides of IRAs is size, specifically how much money you’re allowed to shield from taxes each year. Another drawback is the number of rules that determine the amount you’re allowed to contribute (to a Roth) and how much of an upfront tax break (in a traditional IRA) you’re allowed to take.

Your turn, 401(k)s:

While IRA rules are universal (they apply to everyone), 401(k) rules are set by each company for their own 401(k) plan. As in, who’s eligible to contribute to the plan, which investments are offered, whether there’s a company match, who pays for administration fees and whether loans are allowed. With IRAs you are free to move your account to another provider if you want access to different investments or lower trading fees. Within a 401(k) plan, your hands are tied (at least, as long as you work at that company).

Let’s break down the pros and cons of IRAs vs. 401(k)s feature by feature to see how they stack up:

Contribution limits

IRA:

• IRAs have lower contribution limits than 401(k)s. In 2024, individuals can contribute up to $7,000 in an IRA (or $8,000 if you’re age 50 or older). That’s $16,000 less than the maximum allowed in a 401(k) if you’re under 50, or $22,500 less if you’re over 50.
• There are no “matching” contributions for IRAs. Almost without exception, in an IRA 100% of the savings burden is on you. That is, unless you have a benevolent deity who rewards you with a shower of gold doubloons every time you add money to your IRA. (If you do, we’re open to introductions.)

401(k):

• High contribution limits. The IRS allows individuals to save up to $23,000 a year in a 401(k) in 2024, or $30,500 if you’re 50 or older. Too lofty of a goal? Don’t worry: There’s no minimum amount you’re required to participate, but we do recommend you contribute at least enough to snag any employer match, which brings us to …
• A potential retirement savings boost from your employer. Employers are not required to contribute money to employee 401(k) accounts, but many do. It’s usually in the form of an “employer match,” meaning your boss matches whatever contributions you make up to a certain percentage of your salary. By the way, this money doesn’t count toward the annual 401(k) contribution cap.

Bottom line: When it comes to how much money you’re allowed to save in a tax-favored retirement account, the numbers clearly favor 401(k) plans. Simply by virtue of size, the benefits of 401(k)s dwarf those of IRAs. For example, the reduction in income you’re allowed to report if you fully fund a traditional IRA is less than half of what you can get if you maxed out your 401(k). Plus employer-sponsored accounts allow you to enjoy tax-free or tax-deferred status on a larger portion of your retirement savings.

Accessibility/eligibility

IRA:

• Anyone can open an IRA. As long as you (or your spouse, if you don’t work) have earned income reported to the IRS, you’re eligible to open an IRA. We’d do a mic drop right here, but the IRS would pick it up off the floor and ask us to provide a few caveats. So …
• The IRA type, tax breaks, and amount you’re allowed to save depends. Not everyone is eligible to take full advantage of the tax benefits of traditional IRAs or even contribute to a Roth IRA. Factors like your income, tax filing status, and access to a workplace retirement plan come into play. (See What Is an IRA? for more.)

401(k):

• Your workplace must offer a plan. If it doesn’t, then you’ll need to use an IRA to save. (And if you work for yourself, a SEP IRA lets you save even more for retirement.) For those with access to a 401(k) at work, some plans allow only full-time salaried employees to participate. Others open it up to salaried or hourly part-time employees.
• There might be a waiting period to participate. If your 401(k) institutes a waiting period for new employees to contribute, you could be sitting on the sidelines for a few months and up to a year before you’re allowed to start saving. Some plans also have a vesting schedule for matching contributions.

Bottom line: IRAs are more accessible to more people than 401(k)s. They don’t require you to work for an employer that offers a plan, and there’s even an exception to the earned-income requirement — the spousal IRA — that allows nonworking spouses to set up an account in their own name.

Investment options

IRA:

• IRAs give you unfettered access to an array of investments. In an IRA you can invest in whatever the broker you choose offers, including individual stocks, bonds, ETFs and mutual funds from most of the major fund companies.
• You get to choose where to set up an account. Unlike a 401(k), where you’re required to use the investment firm picked by your company, IRAs allow you to open a retirement account at a provider that best suits your situation and investment needs. See our article on the Best IRA Accounts for help comparing IRA account features, like fees, retirement savings features and customer support.

401(k):

• Investment options are limited. Unlike IRAs, 401(k) plans make participants choose from a limited list of pre-selected mutual funds curated by the plan administrator. Some plans offer a brokerage window you can use to access other types of investments offered at the investment company that manages your plan.
• You may have access to lower-fee investments. Because 401(k)s bring a lot of buying power to the table, your plan may qualify for access to mutual fund shares that have lower fund management fees than those available to individuals investing via an IRA.

Bottom line: If having the world of investment options at your fingertips is important to you, an IRA delivers more choice than a 401(k). On the other hand, if your company offers access to low-fee funds you can’t get on your own, a 401(k) is your in. Our advice: Take advantage of both! You’re allowed to invest in a 401(k) and an IRA during the same year, which gives you access and a break on fees.

Choice of account type (traditional, Roth, etc.)

IRA:

• You get to choose your IRA account type. As long as you’re eligible to contribute to a Roth or traditional IRA — or a spousal IRA or SEP IRA, for that matter — you get to choose. There are still qualification hurdles (covered in detail in our Roth vs. Traditional IRA rules explainer), but your access to a Roth account is not limited by what an employer chooses to offer.

401(k):

• Access to a Roth account (maybe). If your employer offers the choice of a Roth 401(k), you get the choice of when you want your tax break within your workplace plan. This is especially beneficial to those who otherwise do not qualify to contribute to a Roth IRA; income restrictions do not apply to Roth 401(k) eligibility. That said …
• A traditional 401(k) may be your only choice. At year-end 2022, 80% of plans managed by Vanguard offered participants access to a Roth 401(k) feature in addition to a traditional 401(k). For plans that don’t offer a choice, savers who want the benefits of a Roth account are forced to use a Roth IRA, if they meet contribution requirements

Bottom line: For breadth of choice, IRAs win the day. Roth, traditional or other? It’s up to you what type of account to use provided you meet the IRS eligibility requirements.

Tax breaks

IRA:

• Your traditional IRA upfront tax break may be limited. If you and/or your spouse have access to an employer-sponsored retirement plan, then the ability to deduct all — or any — of your contributions to a traditional IRA from your current year’s taxes will depend on your household income. Still, even if your ability to deduct your IRA contributions is limited or entirely prohibited, you can still contribute to a traditional IRA and get tax-deferred growth on your investments. You just won’t get the upfront tax break.
• You may not be eligible to contribute to a Roth IRA. The IRS bases Roth IRA contribution limits on your modified adjusted gross income. The amount you’re allowed to save starts to decrease and eventually disappears once you hit a certain income threshold.

401(k):

• You get an upfront tax break on your entire traditional 401(k) contribution. There’s no worrying about qualifying for a reduction in your income tax bill with your 401(k) contributions. Every dollar you save (up to the allowable limit) qualifies for this upfront tax break.
• Your income doesn’t affect Roth 401(k) eligibility. If your company offers a Roth 401(k) plan your contributions (up to the max) are not limited by your income. This is especially beneficial for those who otherwise do not qualify to contribute to a Roth IRA because of their high income.

Bottom line: 401(k)s don’t have the same eligibility constraints as IRAs when it comes to getting your tax break for saving for retirement. The key point we’ll repeat here yet again is this: Not all 401(k)s offer a Roth option. If yours doesn’t, and you want the advantage of tax-free withdrawals in retirement, you’re at the mercy of the Roth IRA eligibility rules.

Fees

IRA:

• You have a say in how much you pay. Everything from trading costs to account fees to the management fees on any mutual funds you choose is within your control. You’re free to comparison shop among IRA providers, as well as compare similar mutual funds within the brokerage’s vast menu of offerings to keep costs under control.

401(k):

• You may have to pay 401(k) plan administrative fees. The administrative fees for simply running a 401(k) plan can range from less than 0.5% to more than 2% of your assets, depending on the number of participants and amount in assets. Your employer may or may not cover some or all of the cost of administrative fees. (See your 401(k)’s summary plan description to find out.) If you’re required to pay any portion, the amount is automatically deducted from your savings.
• Investment fees are out of your control. Limited investment choices mean limited opportunities to comparison shop for lower-fee options. On the flip side, as we mentioned earlier, you may have access to funds with lower expense ratios than you can get in your IRA.

Bottom line: Fees are the kryptonite of investment returns. The ability to control how much you pay in an IRA makes it come out ahead, especially if you’re stuck with high-fee funds and the tab for administrative costs in your 401(k).

For more pros and cons and details about IRAs and 401(k)s, see What is a 401(k) and What is an IRA?

How to choose: 401(k) or IRA?

IRAs and 401(k)s are both immensely helpful retirement savings tools. As for which type of account is best, even the IRS — the ultimate authority on the topic — takes a neutral position. The IRS allows individuals to save in both a 401(k) and an IRA at the same time.

As noted at the start of this article, if you can afford to contribute to both types of accounts, do so. That guarantees you get the maximum tax benefits on the biggest portion of your retirement savings that you’re allowed.

If your funds are limited, here’s a five-step plan of attack that plays to each type of account’s strengths and minimizes the exposure to their potential shortcomings:

1. Start with the 401(k): If your company matches any of your 401(k) contributions, invest your first savings dollars in a 401(k). This ensures you nab any free money upfront. The exception here is if your company offers no match and has particularly crummy plan fees and investment choices. In that case, skip directly to Step 2.

2. Next, max out an IRA: When you fund an IRA you buy access to a wider variety of investments than what’s available in an employer-sponsored retirement plan. You also have the choice between a Roth and traditional IRA. Funding an IRA is particularly beneficial if your workplace does not offer a Roth 401(k) option and you qualify to contribute to a Roth IRA – that way at least some of your savings will provide tax-free withdrawals in retirement.

3. Return to funding your 401(k): Employer-sponsored retirement plans have much higher contribution limits than IRAs. Therefore, after contributing enough to get any company match and then maxing out an IRA, there’s still room under the 401(k) umbrella to shield more of your money from taxes. Having the option to invest more money in a 401(k) is especially valuable if you don’t qualify to get the full upfront tax on your traditional IRA contribution or are ineligible to contribute fully to a Roth IRA. Income isn’t a factor in eligibility for workplace Roth plans like it is in IRAs.

4. Use a taxable investment account for anything extra. After exhausting all of your tax-preferred retirement savings options, it’s time to funnel any additional money you want to save for the future (go, you!) into a regular investment account at a discount brokerage firm (perhaps the same one you used for your IRA). Although you’re not going to get any tax break for your contributions or tax relief on withdrawals, this type of account provides a very valuable perk: Access to mutual funds, stocks, and other investments that have the potential to out-earn what you might get in interest in a bank savings account. (We have all sorts of thoughts and feelings about finding the best brokerage account for your needs.)

References

IRA contribution limits; 401(k) contribution limits; IRS 2024 contribution limits

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About the Editorial Team

Dayana Yochim is a former Senior Writer/Editor at Reink Media Group who has written about personal finance and investing for more than 20 years. Her work has appeared in outlets including HerMoney.com, NerdWallet and the Motley Fool, and has been syndicated nationally. Dayana has also been a guest expert on "Today" and Good Morning America.

Carolyn Kimball is a former managing editor for StockBrokers.com and investor.com. Carolyn has more than 20 years of writing and editing experience at major media outlets including NerdWallet, the Los Angeles Times and the San Jose Mercury News. She specializes in coverage of personal financial products and services, wielding her editing skills to clarify complex (some might say befuddling) topics to help consumers make informed decisions about their money.

Andrea Coombes has 20+ years of experience helping people reach their financial goals. Her personal finance articles have appeared in the Wall Street Journal, USA Today, MarketWatch, Forbes, and other publications, and she's shared her expertise on CBS, NPR, "Marketplace," and more. She's been a financial coach and certified consumer credit counselor, and is working on becoming a Certified Financial Planner. She knows that owning pets isn't necessarily the best financial decision; her dog and two cats would argue this point.