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IRA vs. 401(k): What are the Key Differences?

by Caldwell Trust

Though many are familiar with both, most don't realize the smaller differences between using a 401(k) and an IRA, especially when asking yourself: which one is the right choice for my retirement savings? The answer will largely depend on your specific situation and your long term financial goals. 

Related Blog: How to Make the Most Out of Your 401(k) Throughout Life


What is a 401(k)? 

A 401(k) is a tax-deferred retirement savings account that employers often offer to their employees. With a 401(k), both the employee and the employer contribute money to the account. The employee does so via elective salary deferrals (in other words, the employee chooses to limit the amount of income he or she directly makes, and instead puts the difference in the 401(k) account). 

In turn, the employer matches the employee's contributions up to a certain amount. 

Contributions to a 401(k) are usually "pre-tax," meaning that you can deduct the amount you contribute to your account from your taxable income for the year. However, you will have to pay tax on your withdrawals in retirement. 


What is an IRA? 

An individual retirement account is a tax-deferred savings account established by an individual, often through a bank, brokerage, or investment firm. Two of the most common IRAs are traditional and Roth accounts. 

Similar to a 401(k), contributions to a traditional IRA are usually "pre-tax." However, contributions to a Roth IRA are "after-tax," meaning that you pay taxes on those contributions upfront, and don't have to do so in retirement. 


What are the Key Differences Between a 401(k) and an IRA? 

There are several differences between these two types of savings account. Without going into too much detail, here are some of the major factors to consider when deciding between a 401(k) and an IRA: 

Account sponsorship-With a 401(k), your employer is responsible to maintain the account, and make any matching contributions up to a predefined limit. In contrast, you can open an IRA through almost any bank or retail brokerage.

Contribution limits and eligibility-As of 2021, the standard contribution limit for an IRA is $6,000 per year (with the option to contribute an additional $1,000 if you are 50+ years old). On the other hand, the contribution limit for a 401(k) is $19,500 per year, with an extra "catch-up" option for those aged 50+ of $6,500. Moreover, employees that earn above specific thresholds are ineligible to make pre-tax contributions to traditional IRAS-or to use Roth IRAs at all.

Investment flexibility—Most 401(k) plans only allow you to invest in approximately 20 mutual funds (or even fewer). IRAs don't come with such restrictions on your investment options.

Fees-Most employees that invest in an employer-sponsored 401(k) plan have to pay fees on their account. In contrast, most brokerage firme don't charge a fee to open or maintain an IRA account. 

Which Option is right for you? 

In general, if you are a highly compensated employee who wants to build a sizable nest egg for yourself, then you may want to invest in a 401(k). If unrestricted investment flexibility is important to you, and you want to have a greater level of control over your savings account, then an IRA may be your preferred choice. 

Of course, no two situations are the same. What works for one person may not work for you. If you'd like some expert assistance in making your decision, reach out to our experienced team at Caldwell Trust today to start the conversation. We'd be happy to help you weigh your options, and make the best choice for you and your family. 

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