IRA vs 401(k): What’s the Difference and How do I Choose the Right One?

Planning for retirement is an important part of achieving long-term financial security, and understanding the available savings options is a key piece of this process. There are a variety of retirement saving vehicles available to employees, but the two most popular tend to be Individual Retirement Accounts (IRAs) and 401(k) Plans. By outlining the different types of IRAs and 401(k) options, as well as offering brief comparisons between them, this guide is designed to provide you with the information necessary to understand what retirement options are best suited for your financial needs.

Overview

Individual Retirement Accounts (IRAs) and 401(k) plans are two of the most widely used retirement savings accounts, each serving the primary purpose of helping individuals set aside funds for their post-employment years. An IRA is a personal savings account that offers individuals flexibility in choosing investments, such as stocks, bonds, and mutual funds, while a 401(k) plan is typically an employer-sponsored account where contributions are often matched by the employer. Employer-sponsored plans also allow participants to choose various investment options, although there are often less options than with Traditional or Roth IRAs.

Both accounts provide significant tax advantages, which play a vital role in the growth of retirement savings. With IRAs and 401(k)s, contributions either grow tax-deferred, meaning taxes are paid upon withdrawal in retirement, or in some cases, tax-free, if utilizing a Roth option. These tax benefits allow savings to compound more effectively over time, making these accounts powerful tools for building a secure financial future.

Types of Individual Retirement Accounts (IRAs)

Traditional IRA

A Traditional IRA is suitable for anyone with earned income who wants a tax-deferred way to save for retirement. Contributions to a Traditional IRA may be tax-deductible, and the account’s earnings grow without being taxed until funds are withdrawn. For 2025 the contribution limit is $7,000, with an additional $1,000 allowed for individuals aged 50 or older.

Anyone can contribute to a Traditional IRA; however, Modified Adjusted Gross Income (MAGI) limits apply when determining if the contribution will qualify as tax deductible. MAGI thresholds are determined based on whether the taxpayer and/or spouse are active participants in an employer sponsored plan. For more information on the applicable phaseout thresholds, please visit IRS.gov.

Note: There is a special rule called the “spousal IRA” that allows a nonworking spouse to contribute to a Traditional IRA based on the working spouse’s earned income. One key rule to remember is that Required Minimum Distributions (RMDs) must begin at age 73 (age requirements for RMDs may vary depending on the birth date of the IRA owner), ensuring that individuals start drawing down their savings and paying taxes on those withdrawals.

Roth IRA

A Roth IRA is designed for individuals who prefer tax-free growth and tax-free withdrawals in retirement. It is ideal for those who anticipate being in a higher tax bracket later in life or who want to avoid paying taxes on their retirement income. Contributions to a Roth IRA are made with after-tax dollars, meaning there is no tax deduction upfront, but the account’s earnings grow tax-free.

For 2025, the contribution limit is $7,000, with an additional $1,000 allowed for those aged 50 or older. For Individuals contributing to both Traditional and Roth IRAs – total contributions between the Traditional and Roth cannot exceed the annual contributions mentioned above.

Contributions to Roth IRAs are subject to MAGI phaseouts without regard to whether an individual is an active participant in an employer sponsored plan. For more information on the applicable phaseout thresholds, please visit IRS.gov.

A major benefit of the Roth IRA is that it has no Required Minimum Distributions (RMDs) during the account holder’s lifetime, and withdrawals can be made tax-free under certain conditions, such as reaching age 59½ and having held the account for at least five years.

SEP IRA

A SEP (Simplified Employee Pension) IRA is primarily designed for self-employed individuals or small business owners looking to contribute toward their own or their employees’ retirement. Employer contributions to a SEP IRA must be made on behalf of each eligible employee. Both pre-tax and after-tax contributions are permitted.

For 2025, the contribution limit for a SEP IRA is the lesser of 25% of compensation or $70,000, making it ideal for those with higher income who want to save more than traditional IRA limits allow. Although SEP IRAs do have RMD requirements, there are no requirements for Roth designated SEP contributions.

SIMPLE IRA

A SIMPLE IRA (Savings Incentive Match Plan for Employees) is tailored for small businesses with 100 or fewer employees. It allows both employers and employees to contribute to the plan, providing an easy-to-administer option for businesses looking to offer retirement benefits. Employer contributions are tax-deductible, and the account’s earnings grow tax-deferred, meaning taxes are paid only upon withdrawal.

For 2025, the employee contribution limit is $16,500, with an additional $3,500 allowed for individuals aged 50 or older and a $5,250 special catch-up for individuals between the ages of 60 and 63. Contribution limits are higher than the limits for traditional and Roth IRAs, but lower than for SEP IRAs. Employers must either match employee contributions up to 3% of compensation or make a fixed non-elective contribution of 2% for all eligible employees, regardless of whether the employee contributes.

Types of 401(k) Plans

Traditional 401(k)

A Traditional 401(k) is a type of employer-sponsored retirement plan that is designed to incentivize employees to save for retirement. It is suited for individuals who want to contribute pre-tax dollars from their paycheck, reducing their taxable income in the present while allowing their investments to grow tax deferred. Pre-tax contributions are a salary reduction in the amount of the employee’s salary deferral in the year of contribution. Contributions to a pre-tax 401(k) grow tax-deferred, meaning earnings are not taxed each year, which allows investments to compound more efficiently over time.

For 2025, the employee contribution limit is $23,500 for employees under age 50. Employees age 50 and older are eligible for a catch-up contribution of $7,500, bringing the total employee contribution limit for 2025 to $31,000. Employees between the ages of 60 and 63 are eligible for a special catch-up contribution of $11,250, bringing the total employee contribution limit for 2025 to $34,750.

Many employers offer matching contributions, or employer non-elective contributions, typically profit sharing, making a 401(k) especially attractive for those looking to maximize their savings with employer support. For 2025, employer and employee contribution limits may not exceed $70,000 plus any age-dependent catch-up contributions for employees over the age of 50.

However, there are specific withdrawal rules: Required Minimum Distributions (RMDs) must begin at age 73. There is one exception to the general rule – employees who are working and are not 5% owners of the business may delay taking RMDs until the year of retirement. Employers that are 5% owners and are still working must begin taking RMDs at age 73. Early withdrawals made before age 59½ generally incur penalties unless certain conditions are met.

Roth 401(k)

A Roth 401(k) combines features of a traditional 401(k) with similar tax benefits of a Roth IRA. It is ideal for employees who prefer to forego the salary deferral and pay taxes on their contributions upfront, allowing their earnings to grow tax-free and enabling tax-free withdrawals in retirement assuming withdrawal requirements are met. Early withdrawals made before age 59½ or before the five-year aging requirement is met will generally incur penalties unless certain conditions are met.

The employee contribution limits for 2025 are the same as a traditional 401(k): $23,500, with an additional $7,500 in catch-up contributions for those over 50 and a $11,250 special catch-up for those who are between the ages of 60 and 63.

Under changes by the SECURE 2.0 Act, employers are permitted to contribute matching contributions to a Roth 401(k). Employees contributing both pre-tax and Roth dollars are subject to the annual employee contribution limits of $23,500, $31,000, or $34,750 based on applicable age. Therefore, the combined total of Traditional and Roth contributions may not exceed the applicable limit, including any age-based catch-up contributions. Like Traditional 401(K) contribution limits, combined employee and employer contributions must not exceed $70,000 plus age dependent catch-up contributions.

Withdrawal rules for the Roth 401(k) are similar to those of a Roth IRA – there are no RMDs during the employee’s lifetime. Employer sponsored plans may have additional withdrawal requirements.

After tax 401(k)

An After-Tax 401(k) is a type of employer-sponsored retirement plan that is best suited for employees who have already maxed out their employee contributions and have taken advantage of their employer contributions but want to save even more for retirement. Contributions are made with after-tax dollars, meaning that the employee will not receive a salary deferral, similar to a Traditional 401(k), while contributions and earnings grow tax-deferred granting earnings to efficiently compound. However, unlike Roth 401(k)s, earnings are considered pre-tax and taxable at the time of withdrawal.

The contribution limit for an After-Tax 401(k) may not exceed the qualified retirement plan contribution limit of $70,000 plus age-dependent catchups for 2025. The $70,000 contribution limit (plus age-based catch-up contributions) includes the following:

• Employer contributions, such as matching and non-elective contributions; and
• Employee contributions, including elective deferrals, whether pre-tax, Roth, or a combination, as well as optional after-tax contributions.

After-Tax contributions provide less tax benefits than Traditional or Roth 401(k) because the employee does not get a salary deferral, but the earnings are taxable. Therefore, After-Tax 401(k) contributions may be ideal for employees that have maximized their salary deferrals and have taken full advantage of employer matching contributions but want to contribute up to the limit.

Withdrawals can be complex. Many individuals choose to convert After-Tax 401(k) contributions to a Roth 401(k) or Roth IRA, and the withdrawal rules will depend on the nature of the account post-conversion, with potential for tax-free withdrawals if properly converted to a Roth account.

Solo 401(k)

A Solo 401(k), also known as an Individual 401(k), is specifically designed for self-employed individuals or small business owners with no employees, other than a spouse. It offers the flexibility to contribute either pre-tax (Traditional) or after-tax (Roth), with the earnings growing tax-deferred or tax-free depending on the type of contributions. One of its key benefits is that contribution limits are higher than those for a traditional or Roth 401(k) because the individual can contribute both as an employee and as an employer.

For 2025, the employee contribution limit is $23,500 with an additional $7,500 in catch-up contributions for those over 50, and a $11,250 special catch-up for those who are between the ages of 60 and 63. The total contribution (including employer contributions) can reach up to $70,000. Withdrawal rules are similar to traditional and Roth 401(k) plans. For Traditional 401(k)s, Required Minimum Distributions (RMDs) must begin at age 73. Roth 401(k) dollars are not subject to RMDs during the employee’s lifetime. Early withdrawals before age 59½ and generally subject to penalties unless certain exceptions apply. In addition to the age requirement, Roth 401(k)s have a five-year aging period.

Key Comparison Factors When Choosing an IRA and/or 401(k)

When comparing IRAs and 401(k) plans, several key factors can help guide the decision.

• Contribution Limits. Contribution limits differ significantly, with 401(k) plans offering higher limits, which can be advantageous for those looking to maximize their retirement savings.
• Tax Treatment. IRAs and 401(k)s both offer pre-tax (traditional) and after-tax (Roth) options, but the choice affects when you pay taxes on contributions and earnings.
• Employer Contributions. These are available in most 401(k) plans through matching programs, providing a major advantage over IRAs, which do not offer employer match options. When it comes to investment options, IRAs typically offer broader choices compared to the more limited selections found in 401(k)s. Lastly, withdrawal rules vary, with 401(k)s and IRAs both requiring RMDs starting at age 73, though early withdrawal penalties apply, with some account-specific exceptions.

When choosing between an IRA and a 401(k), factors such as your age, income level, and employment status play a crucial role. Younger individuals or those in lower tax brackets may benefit more from a Roth account, while those closer to retirement might prefer the immediate tax savings of a traditional plan. Employment status and whether your employer offers a 401(k) with matching contributions can also influence your decision. Finally, aligning your choice with your long-term retirement goals—whether maximizing contributions or prioritizing flexibility in investments—is essential for building a secure financial future.

Choosing between IRAs and 401(k) plans involves evaluating key factors such as contribution limits, tax treatment, employer contributions, investment options, and withdrawal rules. Each account type offers distinct advantages, depending on your personal financial situation, employment status, and long-term retirement goals. Early and informed retirement planning is important for maximizing financial security, as the right choices can significantly impact your savings over time. To ensure the best strategy for your individual needs, it is highly recommended that you consult with a financial advisor who can provide personalized guidance and help you navigate these important decisions.

Disclaimer: The information in this article is not presented as personal, financial, tax, or legal advice and should not be relied upon as a substitute for obtaining advice specific to your situation.