IRA vs 401(k)

An IRA (Individual Retirement Account) and a 401(k) are both retirement savings plans, but they have distinct features and differences. Here's a breakdown of the key distinctions:

1. Who Provides the Plan:

IRA: An IRA is set up by an individual through a financial institution (like a bank, brokerage, or mutual fund). It is a personal retirement savings account, and individuals have control over how much they contribute (within annual limits) and where they invest the funds.

401(k): A 401(k) is an employer-sponsored retirement plan. It is offered through a company or organization, and employees can contribute a portion of their salary to the plan. Employers may also provide matching contributions.

2. Contribution Limits:

IRA: The contribution limit for IRAs in 2025 is $7,000 per year (or $8,000 for individuals aged 50 and older).

401(k): The contribution limit for 401(k) plans in 2025 is much higher, at $23,500 per year (or $31,000 for individuals aged 50 and older). Employer contributions do not count toward this limit.

3. Tax Treatment:

Traditional IRA: Contributions are typically tax-deductible, and investments grow tax-deferred. You pay taxes when you withdraw money during retirement.

Roth IRA: Contributions are made with after-tax dollars, but withdrawals in retirement are tax-free if certain conditions are met.

401(k): Contributions are made with pre-tax dollars, reducing your taxable income in the year of contribution. Like a Traditional IRA, taxes are deferred until you withdraw the funds during retirement. Some employers also offer a Roth 401(k) option, where contributions are made after tax, and withdrawals are tax-free in retirement.

4. Investment Options:

IRA: IRAs typically offer a broad range of investment options, including stocks, bonds, mutual funds, and ETFs. You have more freedom to choose how your money is invested.

401(k): The investment options in a 401(k) are usually limited to a selection of mutual funds, which are chosen by the employer or the plan administrator. You may not have as much flexibility compared to an IRA.

5. Employer Match:

IRA: There is no employer match in an IRA because it is a personal account.

401(k): Many employers offer a matching contribution, meaning they contribute to your 401(k) based on a percentage of your salary, often up to a certain limit. This is a significant advantage, as it essentially provides "free money" to boost your retirement savings.

6. Withdrawal Rules:

IRA: Withdrawals from a traditional IRA before age 59½ generally incur a 10% penalty plus income taxes, though there are some exceptions (e.g., first-time home purchase, education expenses). Roth IRAs allow tax-free and penalty-free withdrawals of contributions at any time, but earnings can only be withdrawn tax-free if you meet certain criteria.

401(k): Early withdrawals from a 401(k) before age 59½ also incur a 10% penalty plus income taxes. Some plans allow loans or hardship withdrawals under specific conditions, but terms vary by employer.

7. Required Minimum Distributions (RMDs):

IRA: Traditional IRAs require you to start taking RMDs at age 73. Roth IRAs do not require RMDs during the account holder's lifetime.

401(k): 401(k) plans also have RMD requirements starting at age 73 unless you're still working for the employer sponsoring the 401(k). Roth 401(k)s are subject to RMDs, but you can roll them over into a Roth IRA to avoid these requirements.

8. Portability:

IRA: You can move or roll over your IRA from one financial institution to another without penalty. You have full control over the account.

401(k): If you leave your job, you can roll over your 401(k) into an IRA or a new employer's 401(k) plan. However, you cannot keep contributing to the old 401(k) unless you’re still employed by that company.

So which plan is better for me?

To maximize retirement savings, strategically leveraging both an IRA and a 401(k) can be highly beneficial. Start by contributing to your 401(k), especially if your employer offers matching contributions—this is essentially free money. Once you’ve contributed enough to receive the full match, consider funding a Traditional or Roth IRA, depending on your income and tax strategy. This approach helps diversify tax advantages and maximize long-term growth.

However, the optimal savings allocation depends on various factors, including income, tax considerations, and retirement goals. A comprehensive financial plan with detailed income, investment and tax projections is essential to determine the best strategy for your specific situation.