IRA vs. 401(k): What's the difference? (2024)

FAQs

IRA vs. 401(k): What's the difference? ›

An IRA is typically held by a brokerage or investment firm. In general, it offers more investment options than a 401(k), but contribution limits are much lower. 6 For tax year 2024, you can't contribute more than $7,000 to an IRA unless you're age 50 or older (up from $6,500 in 2023).

The main difference between 401(k)s and IRAs is that 401(k)s are offered through employers, whereas IRAs are opened by individuals through a broker or a bank. IRAs typically offer more investment options, but 401(k)s allow higher annual contributions.

A traditional IRA is similar to a 401k in that contributions aren't taxed (they are deductible), but the key difference is that they are independent of your employer. A Roth IRA is also independent, but contributions are made after taxes.

A 401(k) may provide an employer match, but an IRA does not. An IRA generally has more investment choices than a 401(k). An IRA allows you to avoid the 10% early withdrawal penalty for certain expenses like higher education, up to $10,000 for a first home purchase or health insurance if you are unemployed.

Roth IRA benefits include a tax break in retirement

Since you contribute after-tax dollars, your earnings and withdrawals are not taxed in retirement. That's a serious advantage to investors, particularly if you're in your 20s or 30s, because of the potential to compound tax-free funds over your working years.

An IRA, or Individual Retirement Account, is a tax-advantaged retirement savings account that offers tax benefits, including income tax-free or tax-deferred growth - which can help your retirement savings grow faster than it would in a traditional savings or investment account.

Generally, from a tax perspective, it is more favorable for participants to roll over their retirement plan assets to an IRA or new employer-sponsored plan rather than take a lump-sum distribution.

Among working-age individuals (ages 15 to 64), the most common type of retirement accounts in 2020 were 401(k)-style accounts (34.6%). About 18% of working-age individuals had an IRA or Keogh account, and 13.5% had a defined-benefit or cash balance plan.

With a Roth IRA, you contribute after-tax dollars, your money grows tax-free, and you can generally make tax- and penalty-free withdrawals after age 59½. With a Traditional IRA, you contribute pre- or after-tax dollars, your money grows tax-deferred, and withdrawals are taxed as current income after age 59½.

When you start withdrawing from your account at retirement age, you will pay taxes on the funds you take out. With a Roth IRA, you contribute to your IRA after you've paid taxes for the year; and when you make withdrawals at retirement age, you don't pay any taxes on the funds you take out.

Is there a downside to an IRA? ›

IRA drawbacks

One drawback of using IRAs to save for retirement is that the annual contribution limits are relatively low. In 2024, you can contribute up to $23,000 to a 401(k) plan, but you can only contribute $7,000 to an IRA in 2024 unless you're at least 50 years old, in which case the limit is $8,000.

Deferring Social Security payments, rolling over old 401(k)s, setting up IRAs to avoid the mandatory 20% federal income tax, and keeping your capital gains taxes low are among the best strategies for reducing taxes on your 401(k) withdrawal.

Age 59½ and over: No Traditional IRA withdrawal restrictions

In other words, you will now owe the taxes that you originally deferred. You can keep taking advantage of tax-deferred contributions regardless of your age as long as you have earned income.

The $1,000 per month rule is designed to help you estimate the amount of savings required to generate a steady monthly income during retirement. According to this rule, for every $240,000 you save, you can withdraw $1,000 per month if you stick to a 5% annual withdrawal rate.

401(k)s offer higher contribution limits.

The 401(k) is simply objectively better. The employer-sponsored plan allows you to add much more to your retirement savings than an IRA – $23,000 compared to $7,000 in 2024.

Key Takeaways. Contributing as much as you can and at least 15% of your pre-tax income is recommended by financial planners. The rule of thumb for retirement savings says you should first meet your employer's match for your 401(k), then max out a Roth 401(k) or Roth IRA. Then you can go back to your 401(k).

If building wealth over the long haul is a top priority for you or your employees, a 401(k) is almost always the better plan. The reason for this comes down to two things: how much employees can defer, and how much control you have over employer contributions.

The median annual 401(k) fee is . 85% of assets. At the same time, IRAs are available for free at most online, low-cost providers, but some brokerages (usually those that offer live financial advice) may charge a recurring fee to hold an IRA open.

For 2024, you can contribute up to $23,000 to a 401(k) unless you're 50 or older, in which case you can contribute an additional $7,500, or $30,500 total. You can also contribute up to $7,000 to an IRA unless you're 50 or older—in that case, you can contribute an additional $1,000, or $8,000 total.