Understanding how best to use different retirement solutions to your advantage can be challenging. A great place to start? Learning the differences between retirement-specific investment accounts like 401(k)s and individual retirement accounts, known as IRAs.
What’s the difference between IRAs and 401(k)s?
Both IRAs and 401(k)s offer tax advantages and investment solutions to help pursue your retirement goals. The main difference between IRAs and 401(k)s is that you open an IRA through a bank or broker, like Ally Bank or Ally Invest, and you access a 401(k) plan through your employer. Other differences involve investment flexibility and contribution limits, which we’ll discuss shortly.
| 401(k) | Traditional IRA |
|---|---|---|
Opened by | Employer | Individual |
Employer match | Sometimes offered | Not available |
2024 contribution limit | $23,000 ($30,500 age 50+) | $7,000 ($8,000 age 50+) |
Investment choices | Limited by employer plan | Variety of choices |
Eligibility | Not limited by income | Can be limited by income |
Read more: Is a robo advisor or financial advisor right for you?
Types of IRAs
IRAs can be used to supplement your 401(k) plan, or you can open one on its own. You can choose from three main types of IRAs to tailor your retirement strategy.
Traditional IRA
Traditional IRAs allow you to typically deduct your contributions (subject to income levels) from your income pre-tax. This means you can put earnings toward investments, and any gains received would be tax-deferred. Your money is then taxed when you take it out.
Roth IRA
With a Roth IRA, you contribute after-tax dollars, so your qualified distributions or distributions that are a return of contributions aren't subject to tax. If you expect to be in a higher tax bracket when you withdraw your money versus when you are contributing, it could be beneficial to consider a Roth IRA.
SEP IRA
Self-Employed Pensions, or SEP IRAs, are typically used as 401(k) alternatives established by small business employers or by you, if you’re self-employed. Like a traditional IRA, SEP IRA contributions are tax-deductible and grow tax-deferred, but contribution limits are higher.
IRAs can be used to supplement your 401(k) plan, or you can open one on its own.
Types of 401(k)S
A 401(k) is an employer-sponsored retirement plan that can be traditional or Roth.
Traditional 401(k)
With a traditional 401(k), your contributions are made pre-tax, which can reduce your taxable income. You pay taxes on the contributions and investment earnings when you make distributions, typically during retirement.
Roth 401(k)
Like Roth IRAs, contributions to a Roth 401(k) come from your after-tax income. Not all employers offer this, but you may find it worth exploring to see if your workplace does. Investment earnings, qualified distributions or distributions that are a return of contributions aren't subject to tax when you withdraw during retirement.
Employee contributions to a 401(k)
A 401(k) allows your contributions to come directly out of your paycheck, typically based on a percentage of your choosing. That means you don’t have to worry about transferring money after you’ve received your paycheck.
Employer matching contributions to a 401(k)
Your employer may offer to match some of your contributions to a 401(k) plan. For example, if you contribute 6% of your income and your employer offers a 3% match, you’ll be investing 9% total. That extra contribution could go a long way toward your retirement goals.
Contribution limits
The IRS sets retirement contribution limits, which are subject to change annually. If you’re over 50 years old, catch-up limits allow you to contribute an additional amount to retirement accounts. In 2024, the contribution limit for an IRA is $7,000, with a catch-up limit of $8,000 for those 50 and older. The contribution limit for a 401(k) is $23,000. Those 50 and older can contribute up to $30,500 in 2024.
Can you have both an IRA and a 401(k)?
Yes, you can have both an IRA and a 401(k) — and doing so may be a great retirement strategy. If you find yourself maxing out your 401(k)and want additional ways to invest, IRAs could help.
Opening an IRA may also give you investment methods, like doing it yourself or using a robo-advisor. If you DIY, you have a variety of investment products to pick from, including mutual funds, exchange-traded funds ( ETFs) and individual stocks and bonds.
You can also open IRA deposit products, like savings accounts and certificates of deposit, at a FDIC-insured bank if you like the idea of a portion of your savings being insured up to the maximum amount allowed by law.
Which is right for you?
Whether you decide to contribute to a 401(k) or IRA first understand whether or not your employer offers to match 401(k) contributions. For some, it may be a good idea to contribute enough to get the maximum match — then get started with IRA contributions. Others might choose to fund an IRA first, then put money toward a 401(k). While there’s no universal right way, making the most of each choice can give your retirement savings an extra boost.
