IRA vs 401(k): How to choose which plan is right for you

A 401(k) is offered by your employer while IRAs are retirement accounts that you open on your own. There is, however, no reason why you can't have both.

While one option is generally sufficient to create a reserve of funds after you retire, there is no reason why you can’t choose both.

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IRAs and 401(k) accounts both serve the same purpose of creating a reserve for life after you retire. They both have similar tax benefits and similar limits on how much you can contribute each year. A 401(k) is offered by your employer while IRAs are retirement accounts that you open on your own.


Traditional IRAs and Roth IRAs offer applicants the flexibility of making tax-deductible contributions up to $6,000 per year for account holders under 50 years old and $7,000 for those over 50 years old.

The returns earned through IRA contributions are tax-free and continue to accumulate during the tenure for which the account is held. 

Taxes are applicable when making withdrawals from IRAs. With traditional IRAs, there is a 10% penalty fee for withdrawals made before the account holder is 59 and a half years old.

Roth IRA withdrawals are free from taxation. Additionally, there is no penalty for making a premature withdrawal from a Roth IRA if you’ve made contributions for more than 5 years.


A 401(k) is an employee retirement plan offered by employers to their employees. With a 401(k) account, a portion of your salary is deposited into the account before taxes.

The same amount is matched by the employer and deposited into the account. Similar to IRAs, the 401(k) offers tax deductions for both the employer and the employee. Likewise, similar to IRAs, returns earned from a 401(k) are tax-free until withdrawal. 

The contribution limit for employees is $19,500 per year for those under the age of 50 and $26,000 for those above the age of 50.

The combined annual employer/employee contribution towards a 401(k) is capped at $58,000 for those under 50 years of age and $64,500 for those over 50. The penalty fee for 401(k)s for premature withdrawal are the same as traditional IRAs.

Many employers also offer their employees Roth 401(k)s. With Roth 401(k)s, the contributions to the account are made after taxes. Roth 401(k)s, similar to Roth IRAs, have tax-free withdrawals and do not attract a penalty fee if withdrawals are made after 5 years of contribution.   

Deciding between IRA and 401(k)

The end goal of both an IRA and a 401(k) are the same: to create a nest egg for life after retirement. However, choosing between both instruments depends on which suits your needs better.

  • 401(k) give account holders the opportunity to make larger annual contributions when compared to IRAs. However, the investment options in a 401(k) are limited and the account holder doesn’t really have a say in where the investments are made. IRAs have lower limits on annual contributions, but offer wider investment options. IRAs also give investors the chance to independently manage their investment, while 401(k)s do not. 
  • Investments made in an IRA is subject to market risk like most mutual fund investments. This means that you could potentially lose money on your investment. 
  • Withdrawals from an IRA can be made at any point during the investment period. When it’s made prematurely, it attracts a penalty fee, but it is still possible to make a withdrawal. With 401(k)s, employees can make withdrawals only if they meet certain criteria: if you no longer work for the employer, being above 59 and half years old, or due to disability. However, employers can permit their employees loans against their account while still part of the 401(k) plan. 

You can choose both

If you have the financial capability to contribute to both the IRA and 401(k), then it is definitely something you should consider. 

Since 401(k)s have employer contributions, it increases the amount you can save significantly. If your employer makes a 100% match of your contribution, and you have the financial flexibility to invest in an IRA, you should certainly make that move.

If your employer does not match your contribution to the 401(k), you could invest in an IRA of your choice and perhaps increase your contribution in your 401(k). 

Investing in a 401(k), lowers your taxable income more than an IRA. Furthermore, if you see your income increasing significantly over the course of your employment, upping your 401(k) contribution can help with keeping your taxable income low while also building a healthy retirement fund. 

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