401(k) or IRA: Which Vehicle Makes Sense (for you).

Key Points to Consider.

Alexander Ognenovski, JD

Associate Advisor

What’ll it be: a 401(k) or an IRA? Given the choice between putting money in an employer-sponsored retirement account such as a 401(k) or a self-directed savings vehicle like a Roth or traditional IRA, the ideal answer is “all of the above.”  But until (or even if) maxing-out both is an option, you do want to prioritize your retirement savings dollars according to a general 401(k) versus IRA pecking order.

Traditional IRA
Contribution Limits:
$18,000 for those under age 50; $24,000 for those age 50 and above. $5,500 as a combined IRA limit; $6,500 for those age 50 and above.
Key Advantages:
Employer match (if offered). Large investment selection.
  High annual contribution limit. If deductible, contributions lower taxable income in the year they are made.
  Contributions lower taxable income in the year they are made.
  Eligibility is not limited by income.
  Funds in a 401(k) may be less expensive than identical fund purchased outside of 401(k).
No control over plan and investment costs. Contribution limits are lower than a 401(k).
  Distributions in retirement are taxed as ordinary income, unless a Roth 401(k). Deduction phased out at higher incomes if you (or your spouse) are covered by a workplace retirement account.
Required minimum distributions beginning at age 70 1/2. Required minimum distributions beginning at age 70 1/2.


Tax Treatment of Contributions:
Contributions made with pre-tax dollars, which reduces your taxable income on a dollar-for-dollar basis. Some employers offer a Roth 401(k) option, funded with after-tax dollars. Contributions are deductible. Higher income and participation in a workplace retirement account (for you or your spouse, if married filing jointly) may reduce or eliminate deduction.
Investments in the account grow tax-deferred. If Roth 401(k), investments grow tax-free. Investments in the account grow tax-deferred.


Investment Options:
A pre-selected list of investments, mainly mutual funds. Some plans have a brokerage option with access to investments outside of the plan. Any investment available through your account provider (stocks, bonds, mutual funds, etc.).
Withdrawals in Retirement Tax:
Distributions are taxed as ordinary income. If Roth 401(k), distributions are tax-free. Distributions are taxed as ordinary income.


Bottom Line:

Fund a 401(k) first if your company offers matching dollars.

Fund an IRA first if your 401(k) doesn’t offer a match. If you max out the IRA, begin contributions to your 401(k).

For those who have the option of a 401(k) and an IRA, employer matching of contributions can significantly tilt the advantage toward investing with a 401(k). For instance, if your employer matches all contributions, that’s equivalent to a 100% return on investment. It would take years in an IRA to achieve that same 100% return.  Over time, those contributions will compound; leading to far more growth over the long term.

There are two other pieces of information to consider when comparing an IRA and a 401(k): cost and flexibility. When you leave your job, you are no longer allowed to contribute to that employer’s 401(k).  You then have to make a choice between keeping your 401(k) with your company or rolling it over to an IRA.  As there are no more matching contributions, cost and flexibility should have greater importance for you.

The Quick Answer.

  • If your employer offers a 401(k) with a company match: Fund your 401(k) up to the point where you get the maximum matching dollars, then consider an IRA. If you max out the IRA for the year, return to the 401(k) and resume contributions there.
  • If your employer doesn’t offer a company match: Skip the 401(k) at first and start with an IRA. After contributing up to the limit, fund your 401(k) for the pre-tax benefit it offers.