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The biggest difference between an IRA vs. a 401(k) is the amount you can save. You can save over three times as much in a 401(k) vs. an IRA — $23,000 versus $7,000 for tax year 2024, and $22,500 versus $6,500 for tax year 2023. But not everyone has access to a 401(k), because these are sponsored by an employer, typically for full-time employees.
“A 401(k) is probably one of the most common retirement vehicles,” says Brian Walsh, a CFP® at SoFi. “A 401(k) will be available through work. Your employer is going to choose whether or not to make a 401(k) available to all the employees. Generally speaking, 401(k)s are the most popular retirement plan employers provide.”
Other than that, a traditional IRA and a 401(k) are similar in terms of their basic provisions and tax implications. Both accounts are considered tax deferred, which means you can deduct the amount you contribute each year — unless you have a Roth account, which has a different tax benefit.
Before you decide whether one or all three types of retirement accounts might make sense for you, it helps to know all the similarities and differences between a 401(k) and a traditional IRA and Roth IRA.
Key Points
• An IRA (Individual Retirement Account) and a 401(k) are both retirement savings accounts, but they have different features and eligibility requirements.
• IRAs are typically opened by individuals, while 401(k)s are offered by employers to their employees.
• IRAs offer more investment options and flexibility, while 401(k)s may have employer matching contributions and higher contribution limits.
• Both accounts offer tax advantages, but the timing of tax benefits differs: IRAs provide tax benefits during retirement, while 401(k)s offer tax benefits upfront.
• Choosing between an IRA and a 401(k) depends on factors like employment status, employer contributions, investment options, and personal financial goals.
How Are IRAs and 401(k)s Different?
The government wants you to prioritize saving for retirement. As a result, they provide tax incentives for IRAs vs. 401(k)s.
In that respect, a traditional IRA and a 401(k) are somewhat similar; both offer tax-deferred contributions, which may lower your taxable income, and tax-deferred investment growth. Also, you owe taxes on the money you withdraw from these accounts in retirement (or beforehand, if you take an early withdrawal).
There is a bigger difference between a Roth IRA and a 401(k). Roth accounts are funded with after-tax contributions — so they aren’t tax deductible. But they provide tax-free withdrawals in retirement.
And while you can’t withdraw the contributions you make to a traditional IRA until age 59 ½ (or incur a penalty), you can withdraw Roth contributions at any time (just not the earning or growth on your principal).
These days, you may be able to fund a Roth 401(k), if your company offers it.
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Other Key Differences Between IRAs and 401(k)s
As with anything that involves finance and the tax code, these accounts can be complicated. Because there can be stiff penalties when you don’t follow the rules, it’s wise to know what you’re doing.
Who Can Set Up a 401(k)?
As noted above, a key difference between an IRA and a 401(k) is that 401(k)s are qualified employer-sponsored retirement plans. You typically only have access to these plans through an employer who offers them as part of a full-time compensation package.
In addition, your employer may choose to provide matching 401(k) funds as part of your compensation, which is typically a percentage of the amount you contribute (e.g. an employer might match 3%, dollar for dollar).
Not everyone is a full-time employee. You may be self-employed or work part-time, leaving you without access to a traditional 401(k). Fortunately, there are other options available to you, including solo 401(k) plans and opening an IRA online (individual retirement accounts).
Who Can Set Up an IRA?
Anyone can set up an individual retirement account (IRA) as long as they’re earning income. (And if you’re a non-working spouse of someone with earned income, they can set up a spousal IRA on your behalf.)
If you already have a 401(k), you can still open an IRA and contribute to both accounts. But if you or your spouse (if you’re married) are covered by a retirement plan at work, you may not be able to deduct the full amount of your IRA contributions.
Understanding RMDs
Starting at age 72, you must take required minimum distributions (RMDs) from your tax-deferred accounts, including: traditional IRAs, SEP and SIMPLE IRAs, and 401(k)s. Be sure to determine your minimum distribution amount, and the proper timing, so that you’re not hit with a penalty for skipping it.
It’s worth noting, though, that RMD rules don’t apply to Roth IRAs. If you have a Roth IRA, or inherit one from your spouse, the money is yours to withdraw whenever you choose. The rules change if you inherit a Roth from someone who isn’t your spouse, so consult with a professional as needed.
However, RMD rules do apply when it comes to a Roth 401(k), similar to a traditional 401(k). The main difference here, of course, is that the Roth structure still applies and withdrawals are tax free.
A Closer Look at IRAs
An IRA is an individual retirement account that has a much lower contribution limit than a 401(k) (see chart below). Anyone with earned income can open an IRA, and there are two main types of IRAs to choose from: traditional and Roth accounts.
Self-employed people can also consider opening a SEP-IRA or a SIMPLE IRA, which are tax-deferred accounts that have higher contribution limits.
Traditional IRA
Like a 401(k), contributions to a traditional IRA are tax deductible and may help lower your tax bill. In 2024, IRA contribution limits are $7,000, or $8,000 for those aged 50 or older. In 2023, IRA contribution limits are $6,500, or $7,500 for those aged 50 or older.
With a traditional IRA, investments inside the account grow tax-deferred. And unlike 401(k)s where an employer might offer limited options, IRAs are more flexible because they are classified as self-directed and you typically set up an IRA through a brokerage firm of your choice.
Thus it’s possible to invest in a wider range of investments in your IRA, including stocks, bonds, mutual funds, exchange-traded funds, and even real estate.
When making withdrawals at age 59 ½, you will owe income tax. As with 401(k)s, any withdrawals before then may be subject to both income tax and the 10% early withdrawal penalty.
What Are Roth Accounts?
So far, we’ve discussed traditional 401(k) and IRA accounts. But each type of retirement account also comes in a different flavor — known as a Roth.
The main difference between traditional and Roth IRAs lies in when your contributions are taxed.
• Traditional accounts are funded with pre-tax dollars. The contributions are tax deductible and may provide an immediate tax benefit by lowering your taxable income and, as a result, your tax bill.
• Money inside these accounts grows tax-deferred, and you owe income tax when you make withdrawals, typically when you’ve reached the age of 59 ½.
Roth accounts, on the other hand, are funded with after-tax dollars, so your deposits aren’t tax deductible. However, investments inside Roth accounts also grow tax-free, and they are not subject to income tax when withdrawals are made at or after age 59 ½.
As noted above, Roths have an additional advantage in that you can withdraw your principal at any time (but you cannot withdraw principal + earnings until you’ve had the account for at least five years, and/or you’re 59 ½ or older — often called the five-year rule).
Roth accounts may be beneficial if you anticipate being in a higher tax bracket when you retire versus the one you’re in currently. Then tax-free withdrawals may be even more valuable.
It’s possible to hold both traditional and Roth IRAs at the same time, though combined contribution limits are the same as those for traditional accounts. And those limits can’t be exceeded.
Additionally, the ability to fund a Roth IRA is subject to certain income limits: above a certain limit you can’t contribute to a Roth. There are no income limits for a designated Roth 401(k), however.
A Closer Look at a 401(k)
Contributions to your 401(k) are made with pre-tax dollars. This makes them tax-deductible, meaning the amount you save each year can lower your taxable income in the year you contribute, possibly resulting in a smaller tax bill.
In 2024, you can contribute up to $23,000 to your 401(k). If you’re 50 or older, you can also make catch-up contributions of an extra $7,500, for a total of $30,500. In 2023, you can contribute up to $22,500 each year to your 401(k). If you’re 50 or older, you can also make catch-up contributions of an extra $7,500, for a total of $30,000.
401(k) catch-up contributions allow people nearing retirement to boost their savings. In addition to the contributions made, an employer can also match their employee’s contribution, up to a combined employer and employee limit of $69,000 in 2024 and $66,000 in 2023.
An employer may offer a handful of investment options to choose from, such as exchange-traded funds (ETFs), mutual funds, and target date mutual funds. Money invested in these options grows tax-deferred, which can help retirement investments grow faster.
When someone begins taking withdrawals from their 401(k) account at age 59 ½ (the earliest age at which you can start taking penalty-free withdrawals), those funds are subject to income tax. Any withdrawals made before 59 ½ may be subject to a 10% early withdrawal penalty, on top of the tax you owe.
When Should You Use a 401(k)?
If your employer offers a 401(k), it may be worth taking advantage of the opportunity to start contributing to your retirement savings. After all, 401(k)s have some of the highest contribution limits of any retirement plans, which means you might end up saving a lot. Here are some other instances when it may be a good idea:
1. If your employer matches your contributions
If your company matches any part of your contribution, you may want to consider at least contributing enough to get the maximum employer match. After all, this match is tantamount to free money, and it can add up over time.
2. You can afford to contribute more than you can to an IRA
For tax year 2024, you can only put $7,000 in an IRA, but up to $23,000 in a 401(k) — if you’re over 50, those amounts increase to $8,000 for an IRA and $30,500 for a 401(k).
For tax year 2023, you can only put $6,500 in an IRA, but up to $22,500 in a 401(k) — if you’re over 50, those amounts increase to $7,500 for an IRA and $30,000 for a 401(k). If you’re in a position to save more than the IRA limit, that’s a good reason to take advantage of the higher limits offered by a 401(k).
3. When your income is too high
Above certain income levels, you can’t contribute to a Roth IRA. How much income is that? That’s a complicated question that is best answered by our Roth IRA calculator.
And if you or your spouse are covered by a workplace retirement plan, you may not be able to deduct IRA contributions.
If you can no longer fund a Roth, and can’t get tax deductions from a traditional IRA, it might be worth throwing your full savings power behind your 401(k).
When Should You Use an IRA?
If you can swing it, it may not hurt to fund an IRA. This is especially true if you don’t have access to a 401(k). But even if you do, IRAs can be important tools. For example:
1. When you leave your company
When you leave a job, you can rollover an old 401(k) into an IRA — and it’s generally wise to do so. It’s easy to lose track of old plans, and companies can merge or even go out of business. Then it can become a real hassle to find your money and get it out.
You can also roll the funds into your new company’s retirement plan (or stick with an IRA rollover, which may give you more control over your investment choices).
Recommended: How to Roll Over Your 401(k)
2. If your 401(k) investment choices are limited
If you have a good mix of mutual funds in your 401(k), or even some target date funds and low-fee index funds, your plan is probably fine. But, some plans have very limited investment options, or are so confusing that people can’t make a decision and end up in the default investment — a low interest money market fund.
If this is the case, you might want to limit your contributions to the amount needed to get your full employer match and put the rest in an IRA.
3. When you’re between jobs
Not every company has a 401(k), and people are not always employed. There may be times in your life when your IRA is the only option. If you have self-employment income, you can make higher contributions to a SEP IRA or a Solo 401(k) you set up for yourself.
4. If you can “double dip.”
If you have a 401(k), are eligible for a Roth IRA, or can deduct contributions to a traditional IRA, and you can afford it — it may be worth investing in both. After all, saving more now means more money — and financial security — down the line. Once again, you can check our IRA calculator to see if you can double dip. Just remember that the IRA contribution limit is for the total contributed to both a Roth and traditional IRA.
The real question is not: IRA vs. 401(k), but rather — which of these is the best place to put each year’s contributions? Both are powerful tools to help you save, and many people will use different types of accounts over their working lives.
When Should You Use Both an IRA and 401(k)?
Using an IRA and a 401(k) at the same time may be a good way to save for your retirement goals. Funding a traditional or Roth IRA and 401(k) at once can allow you to save more than you would otherwise be able to in just one account.
Bear in mind that if you or your spouse participate in a workplace retirement plan, you may not be able to deduct all of your traditional IRA contributions, depending on how high your income is.
Having both types of accounts can also provide you some flexibility in terms of drawing income when you retire. For example, you might find a 401(k) as a source of pre-tax retirement income. At the same time you might fund a Roth IRA to provide a source of after-tax income when you retire.
That way, depending on your financial and tax situation each year, you may be able to strategically make withdrawals from each account to help minimize your tax liability.
The Takeaway
What is the difference between an IRA and a 401(k)? As you can see now, the answer is pretty complicated, depending on which type of IRA you’re talking about. Traditional IRAs are tax deferred, just like traditional 401(k)s — which means your contributions are tax deductible in the year you make them, but taxes are owed when you take money out.
Roth accounts — whether a Roth IRA or a Roth 401(k) — have a different tax treatment. You deposit after-tax funds in these types of accounts. And then you don’t pay any tax on your withdrawals in retirement.
The biggest difference is the amount you can save in each. For tax year 2023, it’s $23,000 in a 401(k) ($30,500 if you’re 50 and over) versus only $7,000 in an IRA ($8,000 if you’re 50+). For tax year 2023, it’s $22,500 in a 401(k) ($30,000 if you’re 50 and over) versus only $6,500 in an IRA ($7,500 if you’re 50+).
Another difference is that a 401(k) is generally sponsored by your employer, so you’re beholden to the investment choices of the firm managing the company’s plan, and the fees they charge. By contrast, you set up an IRA yourself, so the investment options are greater — and the fees can be lower.
Generally, you can have an IRA as well as a 401(k). The rules around contribution limits, and how much you can deduct may come into play, however.
If you’re ready to open an IRA, it’s easy when you set up an Active Invest account with SoFi Invest.
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FAQ
Is a 401(k) considered an IRA for tax purposes?
No. A 401(k) is a completely separate account than an IRA because it’s sponsored by your employer.
Is it better to have a 401(k) or an IRA?
You can save more in a 401(k), and your employer may also offer matching contributions. But an IRA often has a much wider range of investment options. It’s wise to weigh the differences, and decide which suits your situation best.
Can you roll a 401(k) Into an IRA penalty-free?
Yes. If you leave your job and want to roll over your 401(k) account into an IRA, you can do so penalty free within 60 days. If you transfer the funds and hold onto them for longer than 60 days, you will owe taxes and a penalty if you’re under 59 ½.
Can you lose money in an IRA?
Yes. You invest all the money you deposit in an IRA in different securities (i.e. stocks, bonds, mutual funds, ETFs). Ideally you’ll see some growth, but you could also see losses. There are no guarantees.
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