Should I invest in a 401(k) or an IRA?

The answer is—yes! 401(k)s and IRAs both help you save for retirement in a tax-advantaged way. Generally, 401(k) plans are offered by employers and traditional IRAs are individual accounts that can be purchased by anyone. Understanding the differences can help you decide whether 401(k)s or IRAs—or both—are the best way to save for your retirement.

A 401(k) is a workplace savings plan

A 401(k) is a retirement plan offered by an employer just for employees. Its unusual name comes from a line in the tax code, and, depending on the type of organization, an employer’s retirement plan could actually be a 401(k), 403(b), or 457, but these are all variations of the same theme: employer-sponsored savings plans that help employees save for retirement.

Here’s how 401(k)s can be a powerful—yet easy—way to save for the future:

  • First, your contributions are automatically deducted from your paycheck. You set the contribution percentage, or your employer may automatically enroll you, depending on your plan. Regular contributions make it much easier to put money aside—before you can spend it.
  • Second, many employers may offer a matching contribution on your behalf when you contribute, meaning that for every dollar you save for your future, they’ll add a certain percentage. Matching contributions are additional dollars from your employer, above and beyond your pay, to help you build your retirement savings.  

With a 401(k), you pay taxes on contributions and their earnings only when you withdraw money, ideally at retirement, when your tax rate may be lower. 

An IRA is a personal retirement account

As its name suggests, an IRA is an individual retirement account that you can set up to help you save for retirement; you can think of it as your portable, personal retirement plan. The IRA was the first self-directed retirement plan, coming on the scene in 1974, even before 401(k) plans. Over time, though, workplace savings plans gained in popularity over IRAs, which offer fewer benefits. Notably, IRAs don’t offer payroll deductions or matching contributions, the amount you can save in an IRA each year is far less than in a 401(k), and the tax benefits are limited by your overall earnings. That said, roughly half of all American households aren’t offered work-based retirement plans at their current jobs, making an IRA the next best thing.1  

Pie chart showing total amount invested in 401(k)s vs. IRAs

If workplace plans offer so many more perks, why do IRAs have 50% more money invested in them versus 401(k)s? (At the end of 2018, it was $8.7 trillion vs. $5.8 trillion, respectively.2) Because when people switch employers, they often choose to roll over money from their old workplace plan into an IRA. That process, called a rollover, ensures that any tax advantages of the account stay intact until you withdraw the money in retirement. Rollovers can happen multiple times over a person’s career; as a result, Americans can have several accounts, including rollover IRAs and traditional IRAs, in addition to a 401(k) at their current employer.

Retirement planning comparison—401(k)s vs. IRAs

Facts about … 401(k)s IRAs
Who can save Eligible employee whose employer offers a plan Any individual who’s earned income (there’s no age limit)
How much you can contribute each year³

In 2020³:

  • If under age 50: $19,500
  • If age 50+: $26,000

In 2020³:

  • If under age 50: $6,000
  • If aged 50+: $7,000
Income limits No income limits Income limits apply
Investment options Options limited by the plan Wide variety of mutual funds and other investments
Loans Plan loans (and hardship withdrawals) may be available to actively employed individuals participating in the plan Loans aren’t permitted
Matching contributions Employer may match a percentage of employee contributions; there can be a waiting period to become fully vested Not available
Getting started Enroll through employer Open an IRA through one of the many financial institutions offering them (banks, mutual fund providers, financial representatives, etc.)

Make the most of what’s available to you

If you have access to a workplace plan, consider taking full advantage of its many benefits, particularly the company match. If you don’t have access to a 401(k), an IRA may be your next best option. 

If you have money to save and you’ve maxed out your 401(k), you can still make contributions to an IRA. In all likelihood, though, you could end up with both an IRA and a 401(k) at some point in your career.

Now that you know the differences between 401(k)s and IRAs, the important thing is to enroll in one and start saving for retirement. 

1 “Seeing Our Way to Financial Security in the Age of Increased Longevity,” Stanford Center on Longevity, Stanford University, October 2018. 2 “U.S. Retirement Markets 2019: Looking Toward Holistic Solutions for Participants and Plan Sponsors,” The Cerulli Report, Cerulli Associates, December 2019. 3 Annual contribution rates are based on IRS retirement plan limitations (in this case, for 2020). They are subject to change and to plan provisions.

The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made herein.