401(k) vs. IRA: where should your next dollar go?

Key takeaways

• A 401(k) is offered through your employer and allows much higher contributions than an IRA.
• An IRA is an account you open yourself, often with more investment choices and lower fees.
• A common order: contribute enough to get your full 401(k) match, then fund an IRA, then return to the 401(k).

How a 401(k) works

Contributions come straight out of your paycheck, either before tax (traditional) or after tax (Roth, if your plan offers it). Many employers match part of what you contribute. Investment options are limited to the plan’s menu, and fees vary from plan to plan.

How an IRA works

You open an individual retirement account at a brokerage, bank or robo-advisor and choose your own investments. Traditional IRA contributions may be tax-deductible depending on your income and whether you have a workplace plan. Roth IRA contributions aren’t deductible, but qualified withdrawals are tax-free, and Roth eligibility phases out at higher incomes.

Contribution limits

The IRS sets annual contribution limits for both accounts and adjusts them periodically for inflation. 401(k) limits are several times higher than IRA limits, and both allow extra catch-up contributions from age 50. Check the current year’s limits before you set your contribution.

A common order of operations

This sequence balances free money, flexibility and tax benefits.

• Contribute enough to your 401(k) to get the full employer match.
• Pay off high-interest debt and build an emergency fund.
• Contribute to an IRA — often a Roth IRA if you’re eligible — for more investment choice.
• Go back and raise your 401(k) contributions toward the annual limit.
• Invest any additional savings in a taxable brokerage account.

Don’t forget withdrawal rules

Both accounts are designed for retirement. Withdrawals before age 59½ may face income tax plus a 10% penalty, with some exceptions. If you change jobs, you can usually roll an old 401(k) into an IRA or your new employer’s plan.

The bottom line

Take the free money first, then choose the account that gives you the best investments at the lowest cost. Using both accounts lets you save more and diversify your tax situation in retirement.

Frequently asked questions