- 401(k)s are offered by employers, while individuals open and fund IRAs on their own.
- IRAs have more investment options, but 401(k)s have higher contribution limits.
- Both 401(k)s and IRAs offer penalty-free withdrawals after age 59 ½.
- 401(k)s are best for individuals with a company match, while IRAs are best for those without a company match and those who are self-employed.
Is It Better To Have A 401(k) Or IRA?
Whether a 401(k) or IRA is better depends on the individual. Here’s a general guideline of who each is best for:
If your employer offers a 401(k) with a match, take advantage of the free money and contribute at least up to the matching limit. After you’ve reached the matching limit, fund an IRA.
If your employer offers a 401(k) but does not offer a match, consider contributing to an IRA first to take advantage of the wider selection of investment options. If you max out your IRA, then consider contributing to your employer-sponsored 401(k).
If you are self-employed, you won’t have access to an employer-sponsored 401(k). If you have no employees, a solo 401(k) might make sense. Otherwise, contribute to an IRA.
If you are just starting your career, you may be ineligible for a 401(k) until you’ve worked for the company for one year. In the meantime, it might be worth it to contribute to an IRA.
The Difference Between A 401(k) And An IRA
401(k)s and IRAs differ from one another in several ways. The main differences are:
- 401(k)s are offered by employers, while IRAs are not.
- 401(k)s often have a company matching contribution, while IRAs do not.
- 401(k)s have a maximum contribution limit of $22,500 per year, while IRA contributions are maxed out at just $6,500 per year.
| Traditional 401(k) | Traditional IRA | |
|---|---|---|
| Employer-Sponsored | Yes | No |
| Company Match | Sometimes; if so, often around 3-5% | No |
| Eligibility | You must be at least 21 years old and have worked for your employer for one year to contribute. | You must be age 70 ½ or younger and have taxable compensation to contribute. |
| Investment Options | More limited investment selection | Wider selection of investment options |
| Contribution Limits | $22,500 | $6,500, or $7,500 if age 50 or older; or your taxable compensation for the year (whichever is smaller) |
| Tax Implications | Contributions are made with pre-tax dollars, meaning you won’t have to pay income tax on contributions until retirement. | Contributions are made with pre-tax dollars, meaning you won’t have to pay income tax on contributions until retirement. |
| Withdrawal Rules | Penalty-free withdrawals after age 59 ½. Earlier withdrawals may be subject to an additional 10% tax. Minimum distributions are required after age 72. | Penalty-free withdrawals after age 59 ½. Earlier withdrawals may be subject to an additional 10% tax. Minimum distributions are required after age 72. |
401(k)s
A 401(k) in an employer-sponsored retirement account, meaning employers provide — and sometimes help fund — the plan. Employees can contribute a portion of their pre-tax salary to retirement, allowing it to be invested and grow tax-deferred until retirement.
In some cases, employers will offer a company match, matching a certain amount or percentage of the employee’s contribution, up to a certain point, as part of the employee benefits package. Employers match around 4.5% on average, according to a Vanguard study.
Once you reach age 59 ½, you can begin to withdraw funds from the account, and those distributions will be subject to ordinary income tax. After age 72, you’ll be required to make minimum withdrawals each year.
Eligibility
To contribute to a 401(k), you must be at least 21 years old and have worked for your employer for at least one year.
Tax Implications
With a 401(k), you won’t have to pay income tax on contributions. However, any withdrawals you make in retirement will be subject to income tax.
Contribution Limits
As of 2023, employees can contribute up to $22,500 per year to a 401(k).
Investment Options
Some 401(k) plans offer just a few investment options, while others offer dozens. Sometimes, these options are limited to mutual funds and company stock, which might not be the best investment option for you.
In most cases, you’ll have the option to choose how your contributions, and your employer’s contributions, are invested. In other cases, your employer will decide how their contributions are invested.
Withdrawal Rules
You can withdraw from your 401(k) penalty-free after age 59 ½. If you withdraw before that, you may be subject to an additional 10% income tax on the amount of the withdrawal.
After age 72, you will be required to take minimum distributions, or withdrawals.
| Pros | Cons |
|---|---|
| You may receive a company match, which is free money. Higher contribution limits in comparison to an IRA. | Less flexible investment options. You’ll need to work for an employer for at least one year to be eligible. You won’t always be able to choose the investment account provider you work with. |
IRAs
An IRA, or individual retirement account, is opened and funded by an individual. Contributions are often tax-deductible, meaning pre-tax dollars are invested, just like a 401(k). Investments grow tax-free but will be subject to standard income tax once withdrawals are made in retirement.
Because IRAs are funded by an individual, there is no company match. However, IRAs tend to have more flexibility — you can select the brokerage or financial institution you work with, and there are more investment options.
Eligibility
To contribute to an IRA, you must be younger than age 70 ½ and have taxable compensation.
Tax Implications
With a traditional IRA, you won’t have to pay income tax on contributions. However, distributions taken in retirement will be subject to income tax.
Contribution Limits
You can contribute up to $6,500 per year, or $7,500 if you’re age 50 or older, or your taxable compensation for the year — whichever is smaller.
Withdrawal Rules
With a traditional IRA, you must take distributions by April 1st of the year you turn 72. If you withdraw before age 59 ½, you may be subject to an additional 10% tax for early withdrawal penalties.
| Pros | Cons |
|---|---|
| You don’t need an employer to open an IRA. Wider selection of investment options. Ability to choose which investment account provider you work with. | You won’t receive a company match. Lower contribution limit in comparison to a 401(k). |
How To Open A 401(k) Or An IRA
To open a 401(k), reach out to your employer. If a 401(k) is available, you’ll need to sign up with the investment account provider your employer has selected for you. From there, review the investment choices and select the investments best suited for your financial goals. If you have questions throughout the process, contact your company’s HR department for support.
To open an IRA, choose an investment account provider like Wealthsimple, Wealthfront, or Fidelity. Each provider will have their own unique process to open an account, but each has instructions for how to do so. Follow the steps provided, then select the investments you’d like to purchase, and start funding the account.
