What’s the Difference Between an IRA and a 401k?

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If you’ve ever even thought about retirement—and let’s be real, who hasn’t on a daily basis?—then you’ve probably heard about IRAs and 401ks. They both are great for helping you prepare for retirement by adding funds over time that you can use to pay for that fantastic retired life you have planned. 

But really—what’s the difference? Do you need to have both? Is one better than the other? We get questions like this all the time, so let’s break down the differences between an IRA and a 401k. 

Some definitions first.

401ks are employer-sponsored deferred-income plans. That means that your company offers you a retirement plan. You decide how much you want to contribute annually (usually capped at a certain percentage amount, like 6% or 10% of your annual salary). These contributions are not taxed by the government until you start taking withdrawals in retirement age. A number of companies offer an “employer match” where your company will match your contributions up to a certain percentage. So if you pay 6%, your company could match that same 6%, and that’s free money right there. 

IRAs, or individual retirement accounts are also deferred-income plans, similar to the 401k. Sometimes companies will offer them to employees, but more often than not, individuals have to set them up themselves. IRA accounts are generally held by a custodian like a bank or brokerage firm that manages the accounts, but allows the owner to decide what kind of assets to hold in their account, like stocks, bonds, CDs, etc. There are two types of IRAs: traditional ones where you contribute pre-tax income and only pay taxes when you withdraw the money in retirement; Roth IRAs where you contribute after-tax funds that grow tax-free and can be withdrawn tax-free in retirement. 

Difference #1: One is more likely to be offered by an employer than the other.

As in the descriptions above, you can only get a 401k if your employer gives you one. You can get an IRA on your own, or your employer may offer it to you.

Difference #2: Contribution limits between the two are pretty different. 

With a 401k, you can contribute up to $18,000 per year up until you turn 50. Between 50-65, you can add an additional $6,000 per year to catch up. Both types of IRAs have a limit of just $5,500 per year under the age of 50 and $6,500 per year from age 50-65. 

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Difference #3: Investment options vary too.

With an IRA, you can invest your funds in a wide selection of options, and you can be as much or as little invested as you want. With a 401k, though, selection may be limited, and often they come with prepackaged products. 

Difference #4: Employer match only exists on one of them.

You may have noticed that the definition for the IRA didn’t mention anything about an employer match. And that’s because they don’t have the option for one. 401ks do, so if you have access to one through your work, pay into it and get that match. Otherwise, you’re just losing out on free money you can use to live your best retired life. 

So there you have it. While both IRAs and 401ks are very similar in helping you prepare for the future, they both go about it in slightly different ways. But the best part—there’s no rule saying you can’t have both. In fact, most financial advisors would encourage you to have both a 401k and an IRA if you can afford to fund both. That way your retirement will be as comfortable as you want it to be. 

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