IRA vs. 401(k): What's the difference and how to choose one

James Viceconte, Head of Investment Product | Citizens Wealth Management

James joined Citizens Wealth Management in 2022 and is responsible for the curation and management of the investment product suite of ETFs and Mutual Funds, and portfolio models constructed with these products. As a strategic partner, he has over 30 years of experience in financial markets focused on a broad array of public and private equity and fixed income products.

Are you interested in saving for retirement but don't know where to get started? One of the most common ways to do so is through your employer if they offer a retirement savings plan such as a 401(k).

If this option isn't available to you or you want to do more to plan for retirement, you have other options. For this reason, people often use IRAs as part of their retirement savings plan, too.

Let's take a look at the differences between an IRA vs. 401(k).

IRAs and 401(k)s are retirement accounts with tax benefits to help people save more for their future. The most crucial difference between an IRA and a 401(k) is that a 401(k) is a workplace retirement plan. An IRA is something you typically get on your own working with financial institution. You can only use a 401(k) if you have one at your job. On the other hand, anyone with earned income can open and contribute to an IRA.

There are a few other key differences as you decide whether to use an IRA vs 401(k):

The government limits how much you can save through retirement plans each year. However, 401(k)s have much higher contribution limits. In 2024, you can save up to $23,000 in 401(k) if you're younger than 50 and up to $30,000 if you're 50 or older. For an IRA, you can save up to $7,000 if you're younger than 50 and up to $8,000 if you're 50 or older.

Employer matches

Many employers provide 401(k) matching contributions to their employees. They agree to put money in your 401(k) account when you do. For example, an employer might match dollar for dollar until you've saved 3% of your annual salary. This is free extra money for your retirement.

IRAs do not have employer-matching contributions because they aren't connected to a job. Keep in mind this important difference between an IRA and a 401(k) as you decide where to put your money.

IRA vs. 401(k) investment selection

IRAs provide more flexibility with investment selection. You can choose from any of the stocks, bonds, mutual funds, exchange-traded funds (ETFs), and any other investments the company running your IRA offers. With a 401(k), you're limited to your employer's options which often aren't as numerous as with an IRA but still provide a wide selection. 

Plan loans

Many 401(k) plans allow loans. You can borrow up to $50,000 from your retirement balance and then pay the money back. You don't owe taxes or early withdrawal penalties for temporarily taking out your money. IRAs do not allow loans.

Age for retirement withdrawals

Almost all retirement accounts, including IRAs and 401(k)s, come with the intent for you to leave money in them until you turn 59½. If you take money out before then, you may owe income tax plus a 10% early withdrawal penalty. However, one aspect particular to 401(k)s is that if you leave a job where you have one, you may be able to take penalty-free retirement withdrawals as early as age 55.

You may be able to get a 401(k) or IRAs in a traditional or Roth version. Traditional IRAs and 401(k)s give you an upfront tax deduction for your contributions. When you make withdrawals, ideally in retirement, you'll owe income tax.

Roth IRAs and 401(k)s do not offer an upfront tax deduction. You fund these accounts with after-tax dollars. But when you reach 59½, your withdrawals — including both your contributions and the investment gains — are tax-free as long as you meet a five-year ownership condition.

Both traditional and Roth retirement accounts can be useful. The right fit depends on whether you want to save on taxes today or wait to save on taxes in retirement.

IRA income limits

Income limits can restrict the tax benefits of IRAs. In 2024, you cannot contribute to a Roth IRA if you are single and have a modified adjusted gross income (MAGI) over $161,000 or are married and have a joint MAGI over $240,000.

If you have a 401(k), income limits also restrict your ability to claim the traditional IRA tax deduction. In 2024, you can't deduct your contributions if you're single with a MAGI over $87,000 or are married with a joint MAGI over $143,000. However, you could still make non-deductible contributions to a traditional IRA.

A 401(k) does not have income limits. You can use both the traditional and Roth versions and claim the full tax breaks no matter how much you earn.

You can use both an IRA and a 401(k) at the same time. However, chances are you only have so many retirement dollars to save per year and might need to prioritize which account to max out first. Consider these factors:

• Employer matching funds. If your job offers a 401(k) match, prioritize getting all that free money first. Only after you've collected all available matching funds for the year should you consider using an IRA.
• Your income. If you earn more than the annual income limits, you cannot contribute to a Roth IRA or make deductible contributions to a traditional IRA. High earners are usually better off using a 401(k).
• Investment options. Think about your investment strategy. Are all your target investments available in your 401(k)? If not and your employer won't expand the selection, you could use an IRA to access these other options.
• Investment fees. If your target investments are available in both your 401(k) and IRA, check the annual fees. The 401(k) plans may offer less expensive investments than you could get on your own because large employers sometimes qualify for group discounts. See whether an IRA or your 401(k) leads to a better deal.
• Your need for liquid cash. If your 401(k) plan offers loans, weigh this into your decision. A 401(k) loan would give you penalty-free early access to your money in a pinch, while an IRA would not.
• Target retirement age. If you'd like to retire before turning 59½, a 401(k) is better. It would let you start retirement withdrawals at 55 vs. 59 ½ for an IRA.

A rollover transfers money from one retirement plan to another. You generally won't owe taxes for making this transfer, and there is usually no fee.

When you leave a job, you could roll over the old 401(k) into a traditional IRA so you can take your money with you. If you have a 401(k), some plans allow you to transfer money to a traditional IRA while you're still an employee.

You may be allowed to move money into a 401(k) with your current employer from a traditional IRA or a 401(k) from a past job. It depends on the plan rules if these rollovers are allowed.

Note that Roth accounts may roll over to other Roth accounts, but they can't roll to or from traditional accounts without incurring tax implications or using a Roth conversion.

Given their similar tax benefits, both 401(k) plans and IRAs can help you reach your financial goals. A 401(k) is usually better if you have an employer match, plan loans, and discounted investment options.

The 401(k) plans are also better for high earners because they don't restrict the tax benefits. An IRA is better if your top priority is investment selection, and you don't want your retirement plan tied to an employer.

Since you can use both accounts, it could be worth splitting your funds between each to get the best of both worlds. A financial advisor can help you make this decision.

Ready to open an IRA and start saving? Request a call from a Citizens Wealth Advisor that can get you on the path toward retirement.

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