IRA vs. 401(k): 6 Tips for Choosing the Best Retirement Plan

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The individual retirement account vs. 401(k) debate is an opportunity to think about retirement savings — particularly the benefits of tax-advantaged accounts. Although both types of retirement accounts offer tax benefits and allow flexible contributions, they are structured differently.

An IRA is an individual plan, which makes it a good choice for self-employed, part-time or contract workers. A 401(k) is an employer-sponsored plan.

Is It Better To Have a 401(k) or IRA?

Here is an overview to help you quickly compare a 401(k) and IRA.

Feature 401(k) IRA
Tax Tax-deferred contributions Tax-deferred contributions
Investment options Options determined by employer Options determined by the broker you choose
Contributions -$19,500 (2021)
-$26,000 if age 50 or older
-$6,000 (2020)
-$7,000 if age 50 or older
Matching contributions from employer Sometimes No
Withdrawals Withdrawals are taxed Withdrawals are taxed

How To Prioritize Your Money Between an IRA and 401(k)

If you have to choose between an IRA and a 401(k), it helps to understand the advantages of each account.

Advantages of an IRA

IRAs offer several key advantages that appeal to certain investors.

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  • You have more control over an IRA because you own the account.
  • You get to keep an IRA even if you change jobs.
  • You can invest your money in a variety of stocks, bonds, mutual funds and exchange-traded funds.

Advantages of a 401(k)

Although you don’t have as much control over a 401(k), that doesn’t mean you should automatically opt out of your employer’s plan.

If your employer offers a 401(k) match, you should take advantage of it. This match automatically increases your savings.

Say, for example, your employer matches 100% of your 401(k) contributions, up to 3% of your salary. If you make $50,000 and contribute 3%, or $1,500, to your account, your employer will add an additional $1,500 to your account. Your money is yours right from the start. Your employer’s match becomes yours once you’re vested, which typically happens over a period of several years.

That’s $3,000 in your retirement account, and you only paid half of it. Ignoring this perk is throwing away money.

Another advantage is the high contribution limit — $19,500 vs. $6,000 for an IRA. This means a bigger tax write off come April.

If Your Employer Does Not Offer a 401(k) Match

If you’re self-employed or work for someone who doesn’t match 401(k) contributions, consider opening an IRA. As soon as you’ve fully funded it for the year (up to $6,000 or $7,000), divert the rest of your retirement savings to the 401(k).

6 Tips for Choosing an IRA vs. 401(k)

After exploring the defining characteristics of an IRA and a 401(k), you may still have questions. Here are six tips to help you decide between these plans.

1. Find the Best Tax Structure for You

You contribute to both the IRA and 401(k) with pre-tax money. With the 401(k), contributions come from your pay before taxes are taken out. With the traditional IRA, you contribute after-tax income, and then deduct your contribution at tax time.

Having taxes deferred upfront with the 401(k) can allow you to invest more money sooner. This makes it possible to earn a greater return on your investment.

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2. Check IRA vs. 401(k) Contribution Limits

For 2021, you can contribute up to $19,500 to a 401(k). The allowable IRA contribution limit is just $6,000.

Once you reach age 50, the IRS allows catch-up contributions for both IRAs — $1,000 — and 401(k)s — $6,500. If you still need to save a lot for retirement, the 401(k) offers the clear advantage.

3. Evaluate the Investment Growth Options

IRAs offer you more control over your investment options than a 401(k) allows. In a typical 401(k) plan, you’re limited to the investment choices that your employer’s plan offers.

In an IRA, you’re generally free to invest in nearly any investment offered by your broker. You can choose higher growth options with the IRA if your goal is to maximize your money and you have a high tolerance for risk.

4. Add Up the Benefits of 401(k) Employer Match

The IRA is no match for the typical 401(k) when it comes to employer contributions. The IRA does not come with an employer-match program, but with the standard 401(k), your employer is allowed to match a certain percentage of the amount you contribute each year. This benefit can increase your rate of growth exponentially, and it’s one of the most rapid ways to grow your retirement money.

5. Calculate Fees

The 401(k) mutual funds in which 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 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 401(k) than on where you invest. Calculate fees as part of determining total growth potential of your investment.

6. Plan Your Distributions To Reduce Your Taxes: IRA vs. 401(k) Withdrawal Rules

For both traditional IRAs and 401(k) plans, most distributions are fully taxable as ordinary income. In addition, the IRS mandates that minimum distributions from both accounts begin by the year you turn 72 (70 ½ if you turned 70 1½ before Jan. 1, 2020). If you still have some other forms of income, distributions can put you in a higher tax bracket.

Another option to consider is a Roth IRA, which is funded with after-tax dollars. You won’t get a tax deduction on your contributions, but your distributions in retirement are typically tax-free.

You might find your employer offers a Roth 401(k) option, in which case the taxation works the same as with a Roth IRA. Roth accounts reduce what you can save now because you pay taxes upfront. But you can earn greater returns on your investment in retirement because you won’t need to withdraw extra money to cover taxes.

What Is Better: a SIMPLE IRA or a 401(k)?

A Savings Incentive Match Plan for Employees IRA is another type of retirement account. It’s available to small businesses with up to 100 employees.

Employers offering a SIMPLE IRA must contribute a minimum of 2% of each employee’s salary to the employee’s retirement account. Employees have the option to contribute and are always 100% vested in the plan.

This article has been updated with additional reporting since its original publication.

Our in-house research team and on-site financial experts work together to create content that’s accurate, impartial, and up to date. We fact-check every single statistic, quote and fact using trusted primary resources to make sure the information we provide is correct. You can learn more about GOBankingRates’ processes and standards in our editorial policy.

About the Author

After earning a B.A. in English with a Specialization in Business from UCLA, John Csiszar worked in the financial services industry as a registered representative for 18 years. Along the way, Csiszar earned both Certified Financial Planner and Registered Investment Adviser designations, in addition to being licensed as a life agent, while working for both a major Wall Street wirehouse and for his own investment advisory firm. During his time as an advisor, Csiszar managed over $100 million in client assets while providing individualized investment plans for hundreds of clients.

IRA vs. 401(k): 6 Tips for Choosing the Best Retirement Plan
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