401(k) vs. IRA: How to decide

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Key Takeaways

  • The IRA and 401(k) are both investment accounts designed to help you save for retirement

  • But which account is right for you? Can you own both types of accounts?

  • Here are some differences between eligibility, tax implications, contributions limits, and more

If you're considered contributing to a retirement account, you may be overwhelmed with the options. This article will provide a guide path to your retirement future and help you navigate the waters. We’ll talk about the similarities and differences between 401(k)s and IRAs as well as which to invest in if you don't want to max out both.

The IRA and 401(k) share some basic similarities. Both are types of investment accounts designed to help you save and invest money for your retirement. While the money is in the account, the investments within grow and compound tax-free. However, early withdrawals are penalized, except under certain circumstances.

So, how much should you put in an IRA vs. a 401(k)? We'll walk you through the difference between these two types of accounts (and their sub-types) so you can figure out the best place to put your savings.

How does an IRA work? Roth vs. Traditional?

Keep in mind that an IRA—an individual retirement account—can be set up and contributed to on your own. A 401(k) is an employer-sponsored retirement savings plan. So if you are a freelancer, unemployed, or your current company does not offer a 401(k), then an IRA is your only option.

There are two common types of IRA accounts: Traditional IRA and a Roth IRA. Both accounts allow your money to grow tax free. Both traditional and Roth IRAs have some similarities:

  • Both accounts have an annual contribution limit of $7,000 for 2024 ($8,000 for those over age 50).

  • Account owners can invest in most types of stock, bond, and cash investments, including mutual funds, exchange-traded funds (ETFs), and individual stocks and bonds within the account.

A Roth IRA contribution is made with after-tax dollars . Roth IRA eligibility phases out at annual income of $161,000 for single filers. The phase-out starts out at $240,000 for married filers. The Roth IRA retirement account has certain benefits that are lacking in the other retirement choices:

  • There is no required minimum distribution. You never have to withdraw the money and can pass the account on to your heirs.

  • As long as you are older than 59 ½ or meet the required other requirements, the withdrawals from the account are tax-free.

A traditional IRA contribution is made with pre-tax dollars. Contributions to  traditional IRA accounts may or may not be tax-deductible. If you (and your spouse) are not covered by a workplace retirement plan, then your contributions into the plan are deducted from your taxable income.

Your income level also impacts whether your IRA contribution is deductible or not. Although money held within the traditional IRA can grow tax free, there are other stipulations attached to this type of account. For example, account owners must begin taxable required minimum withdrawals (RMD) from the IRA at age 70 ½.

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The following chart lays out the basic characteristics of the traditional IRA vs Roth accounts :

Features Traditional IRA Roth IRA
Who can contribute? You can contribute if you (or your spouse if filing jointly) have taxable compensation You can contribute if you (or your spouse if filing jointly) have taxable compensation and your modified adjusted gross income is below certain amounts (see 2019.
Are my contributions deductible? You can deduct your contributions if you qualify. Your contributions aren’t deductible.
How much can I contribute? The most you can contribute to all of your traditional and Roth IRAs in 2024 is the smaller of $7,000 ($8,000 if you’re age 50+) or your taxable compensation for the year.
    What is the deadline to make contributions? Your tax return filing deadline (not including extensions). For example, you can make 2024 IRA contributions until April 15, 2024.
    When can I withdraw money? You can withdraw money anytime.
    Do I have to take required minimum distributions? You must start taking distributions by April 1 following the year in which you turn age 72 (73 if you reach age 72 after Dec. 31, 2022). Not required if you are the original owner.
    Are my withdrawals and distributions taxable? Yes. If you are under age 59 ½, you may also have to pay an additional 10% tax for early withdrawals unless you qualify for an exception. None if it’s a qualified distribution (or a withdrawal that is a qualified distribution). Otherwise, part of the distribution or withdrawal may be taxable. If you are under age 59 ½, you may also have to pay an additional 10% tax for early withdrawals unless you qualify for an exception.

    How does a 401(k) work?

    A 401(k) is another type of retirement account, created by your employer for the employee’s benefit. Eligible employees have the opportunity to contribute a portion of their salary into the 401(k) account. The amount of your employee contribution reduces your taxable income. In many cases, employers also offer a company match, in which the employer matches a portion of the employee’s contribution into the account. This is often considered “free money” because the contributions are made by the plan sponsor directly into your account.

    A great benefit of the 401(k) over the IRA is the higher contribution limit — employees can contribute up to $23,000 per year into their account in 2024 with a catch-up contribution of $7,500 for those over age 50. Add in the employer’s matching contribution and this is a powerful retirement savings vehicle.

    More about 401(k)s:

    401(k) vs. IRA: How do they compare?

    Now that you understand the basics of each type of account, let’s talk comparisons. Here’s a quick glance at the key differences between the details of an IRA and 401(k):

    401(k)Traditional IRARoth IRA
    OverviewQualified employer-sponsored retirement planIndividual retirement accountSimilar to a traditional IRA, but initial contributions are not tax deductible
    EligibilityMust be employed by a company that offers a 401(k) plan and meet the plan’s eligibility requirementsAnyone may participate and contribute.Must meet certain adjusted gross income requirements. Phase out begins at $161,000 for single filers and $240,000 for couples.
    Tax issuesTax-deferred growth. Pay taxes when distribution occurs. Contributions are deducted from income pre-tax.Tax-deferred growth. Pay taxes when distribution occurs. Roth contributions are made with after-tax dollars. Qualified withdrawals are tax-free.
    Contribution limits for 2024Up to $23,000. Additional $7,500 catch-up contributions for those age 50 and older.Up to $7,000 with $1,000 additional allowed for those age 50 and olderUp to $7,000 with $1,000 additional allowed for those age 50 and older
    Required minimum distributionMust begin withdrawals at age 72 (73 if you reach age 72 after Dec. 31, 2022)Must begin withdrawals at age 72 (73 if you reach age 72 after Dec. 31, 2022)No required minimum distributions
    Investment selectionsMay only invest in those funds available in the plan.Variety of investment selections: stocks, bonds, funds, CDs, etc.Variety of investment selections: stocks, bonds, funds, CDs, etc.

    Which account should I choose? 

    First, if there’s an employer match, you should consider investing in the 401(k) the amount necessary to receive the full employer contributions. You don’t want to ignore free employer money. 

    From there, it becomes a matter of choice. Compare the investment options and cost of the IRA you are interested in to those of the 401(k) plan and determine which one makes the most sense for you.  

    Can I contribute to both a 401(k) and an IRA?

    There’s no easy answer to this question. Consider your options and strive to invest in both if you meet the eligibility guidelines and your personal finances allow it. If not, weigh the advantages and disadvantages of each type of account.

    Trenton Reed is the Manager of Content Strategy at Human Interest. He has nearly a decade of experience writing for Fortune 500 and SMB companies across finance, technology, and other verticals.

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