IRA vs. 401k: 7 Tips for Choosing the Best Retirement Plan

Here's how to plan around 401k versus IRA retirement savings options, tax rules and more.


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The 401k versus IRA debate is an opportunity to think about retirement savings, particularly regarding using a tax-advantaged account. Although both types of retirement accounts offer tax benefits, they are structured differently and provide different ways to save for retirement.

An IRA is typically used by the self-employed, part-time or contract workers, whereas a 401k is an employer-offered plan. Take a look at the defining characteristics of these plans to find the options that will help you save more for retirement.

Find the Best Tax Structure for You
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1. Find the Best Tax Structure for You

Both the IRA and 401k are contributed to with pre-tax money. With the traditional IRA, you wait until tax time to take your deduction, but with the 401k, you do not pay taxes on your deferrals. Having extra cash by having taxes deferred up front with the 401k can allow you to invest more money sooner to earn more interest.

Determine If Contribution Limits Allow You to Save Enough
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2. Determine If Contribution Limits Allow You to Save Enough

For 2017, you can contribute up to $18,000 to a 401k, and employer contributions can bump your total to $54,000 or 100 percent of your compensation, whichever is lower, according to the IRS. For 2017, the allowable IRA contribution limit is just $5,500.

Once you reach age 50, the IRS allows catch-up contributions for both IRAs and 401ks. If you still need to save a lot for retirement, the 401k offers the clear advantage.

Read: 9 Smart Strategies to Maximize 401k Contributions

Consider After-Tax Account Options
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3. Consider After-Tax Account Options

The main difference in saving for retirement with the Roth IRA versus traditional IRA contribution is that the Roth IRA is funded with after-tax dollars. This difference means that if you meet Roth IRA qualifications, you don't get a tax deduction on your contributions, but your distributions are typically tax-free.

You might also find your employer offers a Roth 401k option, in which case the taxation works the same as a Roth IRA. Comparing Roth IRAs versus 401ks is similar to comparing a traditional IRA to a 401k. Roth accounts reduce what you can save now because you pay taxes up front, but you can earn more interest in retirement because you won't need to pay taxes on the distributions then.

Evaluate the Investment Growth Options

4. Evaluate the Investment Growth Options

IRAs offer you more control over your investment options because you are not limited to just what your employer offers. In a typical 401k plan, you're limited to the investment choices that your employer plan offers. In an IRA, you're generally free to invest in a variety of options. You can choose higher growth options with the IRA if you need to maximize your money quickly.

In some IRAs, you can even invest in real estate or collectibles, such as rare coins or artwork. Look up the different tax rules for these types of investments, however. The IRS might subject you to an additional 10 percent tax on early distributions if you invest your IRA in collectibles because the investment amount is considered distributed in the year invested.

Add Up the Benefits of 401k Employer Match
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5. Add Up the Benefits of 401k Employer Match

The IRA is no match for the typical 401k when it comes to employer contributions. The IRA does not come with an employer-match program, but with the average 401k, your employer is allowed to match a certain percentage of the amount you contribute each year. For example, if you contribute 3 percent of your salary, your employer might contribute 3 percent, effectively earning you a 100 percent return on that money immediately. This benefit will increase your rate of growth exponentially over investment interest rates, and it's one of the most rapid ways to grow your retirement money.

Related: 10 Big 401k Questions to Ask Your Employer

Calculate Your Fees to Increase Your Growth Potential
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6. Calculate Your Fees to Increase Your Growth Potential

The 401k mutual funds you invest in carry an expense ratio that can eat away at your investment value over time. In an IRA, you might pay commissions for any other investments you buy or sell, such as stocks. You might also have to pay a fee to maintain an IRA at certain financial institutions. Fees are less dependent on whether you have an IRA or 401k than on where you invest, so always calculate fees as part of determining total growth potential of your investment.

Plan Your Distributions to Reduce Your Taxes
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7. Plan Your Distributions to Reduce Your Taxes

For both traditional IRAs and 401k plans, most distributions are fully taxable as ordinary income. In addition, the IRS mandates that minimum distributions from both accounts must begin once you turn age 70 ½, but 401ks and other defined-contribution plans can be subject to required minimum distributions upon retirement regardless of age. If you still have some other forms of income, distributions can put you in a higher tax bracket, so you might need to make a larger withdrawal before distributions start to avoid unnecessary taxes.

Up Next: 10 IRA Withdrawal Rules You Need to Know