When planning for retirement, you are likely to encounter two main types of accounts: the 401(k) and the Individual Retirement Account (IRA). While both offer tax advantages to help you save, they work in slightly different ways.
Quick Comparison
- 401(k): Employer-sponsored, higher limits, often has a "match".
- IRA: Individual account, more investment choices, lower limits.
The 401(k): Employer-Sponsored Power
A 401(k) is offered through your employer. The biggest advantage of a 401(k) is the employer match. Many companies will match your contributions up to a certain percentage of your salary. This is essentially free money.
- Contribution Limits: Generally higher than IRAs ($22,500 for 2023).
- Investment Options: Limited to the funds selected by your employer's plan.
- Ease of Use: Contributions are deducted directly from your paycheck.
The IRA: Individual Control
An IRA is an account you open yourself at a brokerage (like Vanguard, Fidelity, or Schwab). It gives you much more freedom.
- Contribution Limits: Lower than 401(k)s ($6,500 for 2023).
- Investment Options: You can invest in almost any stock, bond, or ETF available on the market.
- Flexibility: You control the account entirely, regardless of where you work.
Traditional vs. Roth
Both 401(k)s and IRAs come in "Traditional" and "Roth" varieties:
- Traditional: You get a tax break now (contributions reduce taxable income), but pay taxes when you withdraw in retirement.
- Roth: You pay taxes now, but withdrawals in retirement are 100% tax-free.
Which Should You Prioritize?
A common strategy is to contribute enough to your 401(k) to get the full employer match, then max out an IRA (often a Roth IRA) for better investment choices, and finally go back to the 401(k) if you have more to save.
What Happens When You Change Jobs?
When you leave a job, you can leave your 401(k) there (if the balance is high enough), roll it over into your new employer's plan, or roll it over into an IRA. Rolling it into an IRA usually offers the most control and lowest fees.
Required Minimum Distributions (RMDs)
For Traditional 401(k)s and IRAs, the government requires you to start withdrawing money (and paying taxes on it) once you reach age 73. Roth IRAs do not have RMDs during the owner's lifetime, which is a significant estate planning benefit.