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An IRA egg and a 401(k) egg on $20 bills

In the showdown of IRA vs. 401(k), which wins? That depends on your retirement savings needs. Just because you have access to a 401(k) through work doesn’t mean you should necessarily max it out. Consider what a 401(k) and an IRA can do for you before investing your hard-earned dollars in one or the other. Let us walk you through the important differences between 401(k)s and IRAs. It always makes sense to consult with a financial advisor as you work on a retirement plan.

IRAs vs. 401(k)s Defined

Before we delve into the differences, let’s first establish what an IRA and a 401(k) are. A traditional IRA, or individual retirement account, is a retirement savings account available to anyone under the age of 70 1/2, as it’s not offered through an employer.

A 401(k) is a qualified employer-sponsored retirement plan that’s available only if your employer chooses to offer it. Both 401(k)s and traditional IRAs are solid options for tax-advantaged retirement savings, as you don’t pay taxes on your contributions until after you withdraw your money during retirement.

Three Ways IRAs and 401(k)s Differ

Difference 1: Contribution Limits

401(k)s have higher contribution limits than IRAs. In 2022, you can contribute up to $6,000 a year to an IRA. The maximum contribution limit for a 401(k), on the other hand, is $20,500. The catch-up contributions means folks 50 and over can put a total of $7,000 for IRAs and $27,000 for 401(k)s.

It’s easy to see that the 401(k) boasts significantly higher contribution limits. If you’ve got a high salary – or even if you don’t but you’re serious about saving a lot for retirement – the 401(k) lets you save more.

Difference 2: How You Contribute

IRA vs. 401(k)

Anyone who meets the investment minimum (usually $1,000 but sometimes less) can easily open an IRA with a brokerage firm online. 401(k)s, though, are offered through private-sector employees. You can’t hop on the internet and open a 401(k) for yourself. You must work for a company that offers you access to a 401(k).

Whereas you contribute to an IRA by sending money to the brokerage firm that holds your account, your 401(k) contributions are generally deducted from your paycheck at work before you even see the money. That can make it easier to save. With a 401(k) you’re not tempted to spend the money because it never hits your paycheck. If you’re having trouble committing to a savings plan a 401(k) might be the hack that puts you on the right track.

Difference 3: Portability

If you leave the company that sponsors your 401(k) you can’t keep contributing to it. You can either leave it where it is, roll it over to an IRA or roll it over to a 401(k) at your new company. IRAs, on the other hand, aren’t attached to your employer. You don’t have to jump through any hoops if you change jobs.

IRA vs. 401(k)

IRA vs. 401(k): Which Is Better for You?

Still not sure which one to pick in the battle of IRA vs. 401(k)? One major thing to consider when deciding between a 401(k) and an IRA is employer matching. Some companies offer to match employees’ 401(k) contributions up to a certain amount. For example, an employer may match your contributions up to 6% of your salary. That’s money you should absolutely take. Failing to contribute enough to your 401(k) to get the maximum employer match is leaving money on the table. Dude, it’s free money!

After you’ve contributed enough to get the biggest employer match possible, you can either continue contributing to your 401(k) or contribute to an IRA. If the 401(k) options available to you have relatively high fees you may want to stop contributing once you’ve earned the full match and instead contribute to a low-fee IRA.

The Benefits of Having Both an IRA and a 401(k)

There’s no rule against saving for retirement in both a 401(k) and a traditional IRA. Depending on your income, though, you might not be able to deduct your contributions to the IRA if you’re also saving in a 401(k). That’s because the IRS imposes income limits to restrict who can make tax-deductible contributions to both a 401(k) and an IRA. For tax year 2022, if you’re filing as an individual and your AGI is $78,000 or more you can’t deduct your IRA contributions. Married filing jointly? The income limit is $129,000.

An Alternative: What About a Roth  IRA?

A Roth IRA may make more sense than a traditional IRA as a complement to a 401(k) account. Why? Roth IRAs have a different set of tax advantages. Both IRAs and 401(k)s are tax-deferred accounts. Start taking distributions from them in retirement and you’ll owe income taxes on the money you withdraw. So, if you have both a traditional IRA and a 401(k) you’re doubling up on the same tax strategy. If your taxes are high in retirement you’ll just have to deal.

Plus, both 401(k)s and traditional IRAs come with Required Minimum Distributions (RMDs). Once you hit age 70.5 you’ll have to start taking distributions from the account. If you have other income sources, taking those RMDs can mean you’re forced to withdraw more money than you need and you might get bumped to a higher tax bracket in the process. Bummer.

Roth IRAs, unlike traditional IRAs, are funded with after-tax dollars. As a result, distributions you take from a Roth IRA in retirement are tax-free. Sweet! Having both a 401(k) and a Roth IRA gives you more flexibility to manage your income-to-tax ratio in retirement.

Of course, there are income limits that govern who is eligible to contribute to a Roth IRA, but contributing to a non-deductible IRA and converting it to a Roth can help you get around those limits. Remember that the $6,000 annual limit for contributing to an IRA applies to all of your IRAs, so if you have a traditional IRA and a Roth IRA you can’t contribute $6,000 to each one.

Bottom Line

Having enough money to save for retirement puts you in a privileged position relative to many Americans. The important thing to keep in mind is that a) you should always take advantage of an employer match and b) you want a retirement plan with low fees. The more accounts you hold, the more you’ll pay in fees and the more work you’ll have to put into making sure your assets are balanced across all those accounts.

Tips for Saving for Retirement

  • If you haven’t started saving for retirement, start now. The sooner you start saving up, the more you can reap the benefits of compound interest. With our 401(k) calculator, you can see how much your 401(k) will be worth by the time you’re ready to retire.
  • Get a clear picture of how much you’ll need to save to retire comfortably. By ironing out details ahead of time, like when you want to retire and how retirement tax-friendly your state is, you’ll know if you’re actually tucking enough away. Check here to see if your retirement savings are on par with your peers’.
  • Consider working with a financial advisor as you work on a retirement savings plan. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

Photo credit: © iStock/jygallery, © iStock/vm, © iStock/malerapaso

Amelia Josephson Amelia Josephson is a writer passionate about covering financial literacy topics. Her areas of expertise include retirement and home buying. Amelia's work has appeared across the web, including on AOL, CBS News and The Simple Dollar. She holds degrees from Columbia and Oxford. Originally from Alaska, Amelia now calls Brooklyn home.
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