401k vs. IRA: Which is right for you?

So you feel like you have to choose between a 401k and an IRA. 

The good news is we’ll help you decide which is right for you. The better news is you have the option to contribute to both in the same year, if you choose.

In this guide, we’ll help you navigate the key considerations when deciding between an IRA and a 401k for your retirement savings.

Understanding the Difference Between a 401k and an IRA

Who can participate?

  • IRA: Anyone with earned income can participate in an IRA, whether employed or self-employed.
  • 401k: Participation in a 401k is typically limited to employees whose employers offer this retirement plan.

How much can you contribute? (2024):

  • IRA: $7,000, or $8,000 if you’re over 50.
  • 401k: 401k plans have a higher contribution limit — 23,000, or $30,500 if you’re over 50.

What’s available to you?

  • IRA: IRAs offer both Traditional and Roth options, giving you flexibility to choose the type of account that suits your financial situation and tax preferences.
  • 401k: The availability of Traditional and Roth options in a 401k depends on the specific plan offered by your employer. Not all 401k plans provide both options.

What do the plans invest in?

  • IRA: IRAs offer a wide range of investment options, including ETFs (Exchange-Traded Funds), stocks, bonds, and mutual funds. You have the freedom to choose how you want to invest your funds.
  • 401k: 401k plans typically offer a set of preselected investments chosen by your employer or the plan administrator. The investment choices may be more limited compared to IRAs.

Can you choose your financial institution?

  • IRA: When you have an IRA, you have the freedom to choose the financial institution where your account is held. You can select an IRA custodian or brokerage that aligns with your investment preferences.
  • 401k: In a 401k, your employer selects the financial institution or plan provider for the account. Employees typically don’t have the option to choose the institution that holds their 401k funds.

Advantages of a 401k over an IRA

A 401k is a tax-advantaged retirement savings account typically provided by your employer. Most plans are tax-deferred, which means you receive a tax deduction for your contributions in the current year, and your investments have the potential to grow over time. It’s a common vehicle for retirement savings.

One significant benefit of a 401k is its substantial contribution limit. In 2024, you can contribute up to $23,000. If you contribute the maximum, you’ll receive a tax deduction for the full amount, reducing your tax liability for the year. Simultaneously, you’ll have $23,000 in tax-deferred retirement investments with growth potential.

Many 401k plans also offer matching contributions from employers. This incentive encourages employees to contribute to their 401ks. Employers often match a percentage of employee contributions, typically ranging from 3% to 6% of the employee’s salary.

For example, if you earn $100,000 annually and your employer matches 5% of your annual compensation for 401k contributions, contributing $5,000 to your 401k would result in your employer contributing another $5,000, totaling $10,000 in your account for future compounding.

401k plans may have specific employer-specific rules such as vesting schedules and the option for 401k loans. Some plans even offer Roth 401k options, allowing after-tax contributions with tax-free withdrawals in retirement.

Advantages of IRAs over a 401ks

An IRA, or Individual Retirement Arrangement, is another retirement savings option often used alongside a 401k. While the goal is the same as a 401k – to fund retirement expenses – there are key differences.

An IRA is entirely separate from your employer, requiring you to open one independently at an independent brokerage firm. There are different types of IRAs, but the main ones are Traditional IRAs and Roth IRAs. The contribution limit for IRAs in 2024 is $7,000, or $8,000 if you’re over 50.

Traditional IRA:

  • Typically “pre-tax” and funded with “deductible” contributions.
  • Contributions may be tax-deductible, depending on various IRS factors.

Roth IRA:

  • “After-tax” IRA where contributions are made with already-taxed income.
  • Contributions must fall within IRS income limits.
  • Offers tax-free growth and withdrawals.

When to Choose a 401k vs. an IRA:

You can have both a 401k and an IRA simultaneously, but your financial circumstances may determine which to prioritize.

Choose a 401k when:

  • Your employer offers a match. Any match is essentially free money that only compounds over time.
  • You want to maximize contributions to take advantage of the match.
  • You’re subject to higher administrative fees and limited investment options in your 401k.

Choose an IRA when:

  • Your employer doesn’t offer a 401k match.
  • You want more investment options and lower fees.

Can You Have Both a 401k and an IRA?

Yes, you can have both accounts simultaneously and contribute to both in the same year. A 401k is employer-sponsored, while an IRA is independent. Contributing to both is generally advisable, though eligibility for tax deductions on IRA contributions depends on your income and other factors.

Should You Keep Your 401k or Roll Over to an IRA?

The decision depends on various factors. Some 401k plans have higher fees and limited investment options, making IRAs more flexible and portable. Consider the quality of your new employer’s 401k plan if you’ve switched jobs. Consolidating previous 401k accounts can also be beneficial.

In summary, having both a 401k and an IRA is often a wise financial move, but the choice depends on your unique circumstances and financial goals. Evaluate your options carefully to make the best choice for your retirement savings.

Leave a Reply