IRA vs. 401(k): Which Should You Open First?

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Both IRAs and 401(k) plans offer a way to save on taxes while saving for retirement. But choosing between each account requires learning a bit more about how each account functions–and how they can fit into your financial goals.

Although both types of retirement accounts offer tax benefits and allow flexible contributions, they are structured differently. An IRA is an individual plan, which makes it a good choice for self-employed, part-time or contract workers. A 401(k) is an employer-sponsored plan that you can access through your workplace.

Here’s how to compare the two accounts:

At a Glance: IRA vs. 401(k)

Here is an overview to help you quickly compare a 401(k) and both types of IRAs.

What Is the Advantage of a 401(k) Over an IRA?

If you have to choose between an IRA and a 401(k), it helps to understand the advantages of each account.

Advantages of an IRA

IRAs offer several key advantages that appeal to certain investors:

• You have more control over an IRA because you own the account.
• You get to keep an IRA even if you change jobs.
• You can invest your money in a variety of stocks, bonds, mutual funds and exchange-traded funds.

Advantages of a 401(k)

Although you don’t have as much control over a 401(k), that doesn’t mean you should automatically opt out of your employer’s plan.

If your employer offers a 401(k) match, you should take advantage of it. This match automatically increases your savings.

Say, for example, your employer matches 100% of your 401(k) contributions up to 3% of your salary. If you make $50,000 and contribute 3%, or $1,500, to your account, your employer will add an additional $1,500 to your account. Your money is yours right from the start. Your employer’s match becomes yours once you’re vested, which typically happens over a period of several years.

That’s $3,000 in your retirement account, and you only paid half of it. Ignoring this perk is throwing away money.

Another key advantage of a 401(k) is the high contribution limit — $23,000 vs. $7,000 for an IRA.

Advice

If you work for an employer that doesn’t match 401(k) contributions, consider opening an IRA. As soon as you’ve fully funded it for the year (up to $7,000, or $8,000 if you’re 50 or older), divert the rest of your retirement savings to the 401(k).

Is It Better To Have a 401(k) or an IRA? 

After exploring the defining characteristics of an IRA and a 401(k), you may still have questions. Here are six tips to help you decide between these plans.

1. Find the Best Tax Structure for You

You contribute to both an IRA and a 401(k) with pretax money. With a 401(k), contributions come from your pay before taxes are taken out. With a traditional IRA, you contribute pretax income, and then deduct your contribution at tax time, up to certain income limits.

Having taxes deferred upfront with a 401(k) can allow you to invest more money sooner. This makes it possible to earn a greater return on your investment.

You can also choose a Roth IRA or Roth 401(k), which doesn’t save on taxes now, but allows tax-free withdrawals at retirement. This gives you an advantage if you think your income tax rate will be higher in retirement.

2. Check IRA and 401(k) Contribution Limits

For 2024, you can contribute up to $23,000 to a 401(k). The allowable IRA contribution limit is just $7,000.

Once you reach age 50, the IRS allows catch-up contributions for both IRAs — $1,000 — and 401(k)s — $7,500. If you still need to save a lot for retirement, the 401(k) offers a clear advantage.

3. Evaluate the Investment Growth Options

IRAs offer you more control over your investment options than a 401(k) allows. In a typical 401(k) plan, you’re limited to the investment choices that your employer’s plan offers. These investments may also come with high fees.

In an IRA, you’re generally free to invest in nearly any investment offered by your broker. You can choose higher growth options with an IRA if your goal is to maximize your money and you have a high tolerance for risk.

4. Add Up the Benefits of Your Employer’s 401(k) Matching Program

An IRA is no match for a typical 401(k) when it comes to employer contributions. An IRA does not come with an employer-match program, but with the standard 401(k), your employer is allowed to match a certain percentage of the amount you contribute each year. This benefit can increase your rate of growth exponentially, and it’s one of the most rapid ways to grow your retirement money.

Good To Know

A Savings Incentive Match Plan for Employees IRA is another type of retirement account. It’s available to small businesses with up to 100 employees.

Employers offering a SIMPLE IRA must contribute a minimum of 2% of each employee’s salary to the employee’s retirement account. Employees have the option to contribute and are always 100% vested in the plan.

5. Calculate Fees

The 401(k) mutual funds in which you invest carry an expense ratio that can eat away at your investment value over time. In an IRA, you might pay commissions for any investments you buy or sell, such as stocks.

You might also have to pay a fee to maintain an IRA at certain financial institutions. Fees are less dependent on whether you have an IRA or a 401(k) than on where you invest. Calculate fees as part of determining the total growth potential of your investment.

6. Plan Your Distributions To Reduce Your Taxes

For both traditional IRAs and 401(k) plans, most distributions are fully taxable as ordinary income. In addition, the IRS mandates that minimum distributions from both accounts begin by the year you turn 72, or 73 if you turn 72 after Dec. 31, 2022. If you still have some other forms of income, distributions can put you in a higher tax bracket.

Another option to consider is a Roth IRA, which is funded with after-tax dollars. You won’t get a tax deduction on your contributions, but your distributions in retirement are typically tax-free.

You might find your employer offers a Roth 401(k) option, in which case the taxation works the same as with a Roth IRA. Roth accounts reduce what you can save now because you pay taxes upfront. But you can earn greater returns on your investment in retirement because you won’t need to withdraw extra money to cover taxes.

How To Open a 401(k) Account

To open a 401(k) account, you’ll need to contact your human resources department at your workplace to ask about retirement accounts. If your work offers a 401(k) account, you can ask about enrolling in the plan.

Enrollment may include filling out your investment preferences, contribution amount, which is typically a percentage of your paycheck, and it should include details of any company match that is included. Once you fill out the enrollment form, it may take a few paycheck cycles to kick in.

Once you’ve enrolled in your workplace 401(k) plan, contributions will be automatically deducted from your paycheck.

How To Open an IRA

To open an IRA, you’ll first need to pick a trusted broker that offers IRAs. Reputable brokers like Vanguard, Fidelity and Schwab don’t charge fees to open an IRA and offer access to stocks, bonds, ETF and mutual funds with low costs.

After choosing a broker, you’ll need to create an account online and choose what type of account you wish to open. You’ll then fill out an application–which will feel similar to opening a bank account–by providing personal and financial information.

Once you’ve completed the application, you’ll need to choose how to fund your IRA–which typically involves linking your bank account. Once the account is open, you can choose to fund the account or set up recurring investments on a regular schedule.

Jacob Wade contributed to the reporting for this article.

This article has been updated with additional reporting since its original publication.

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