401(k) vs. IRA—Which is the Better Option for You?

When I meet with the employees of businesses we serve, I often get the question, “Should I invest in my company 401(k), or an IRA outside of work?” Both a 401(k) and IRA are great options for tax-advantaged saving—plus you can always do both.

But if you have the option of choosing to invest in your employer’s 401(k) plan vs. your own IRA, how do you prioritize between the two?

What’s the difference between a 401(k) and an IRA?

Both a 401(k) and an IRA are retirement plans that allow people to save money for retirement and defer paying taxes on any income saved until it's withdrawn during retirement. A 401(k) is an employer-sponsored retirement plan, which means you have to be offered a 401(k) through an employer. In a 401(k), you can elect to save a portion of your income directly to your plan and invest it. Your employer may also offer an employer match, which means they will match the money you save up to a certain percentage of your salary (or dollar amount). On the other hand, “IRA” stands for “individual retirement account,” and anyone who earns wages can get one. Some IRAs, called “Roth IRAs,” allow you to pay taxes on your income before investing it, so you don’t have to pay any taxes in retirement when you withdraw your money.

If your employer offers a 401(k), the first question you should ask is whether your employer offers a matching contribution. A 401(k) match is an instant return on your investment, and in most cases, it would take years to create that growth via market returns alone. An example of a common 401(k) matching contribution might be a 50% match up to a percentage of your salary—meaning that if you were to invest $2, you get $1 back, for a 50% return (up to whatever limits your employer has set). Now consider that 30-year rolling stock market returns have averaged a little better than 8% per year.1 Contributing to get your match nets you an immediate 50% return on your dollar—a clear, immediate benefit that will continue to grow with the market.

The second question you should ask yourself is whether you’ll want to keep track of two accounts—and whether you want to go through the work of self-managing an IRA and making regular contributions. As an employee, payroll deductions are simply much easier; they’re automatic and require no additional input after the initial setup. So if you don’t think you’ll want to commit to the upkeep required to properly maintain an IRA, the best answer for you would be to stick with contributing to the company 401(k).

Regardless, there are advantages and disadvantages involved with saving into 401(k)s and IRAs. Below are some key takeaways I discuss with employees that cover the pros and cons of both a 401(k) and an IRA.

Key takeaways for a 401(k)

•    Higher contribution and catch-up limits. The clearest surface-level difference between a 401(k) and IRA is the difference in contribution limits. With a 401(k), employees can save up to $20,500 per year (for 2022), plus an additional $6,500 for those 50 and over. With an IRA, the limits are far lower at $6,000 per year, plus an additional $1,000 for those 50 and over. If the 401(k) also utilizes profit sharing, the total contribution limits are boosted to $61,000 (for 2022), with an additional $6,500 for those 50 and over.

•    Investments are more limited, but tend to be higher-quality. Due to the way group plans are structured and funds are pooled in a business 401(k), the investment menu usually consists of lower cost options that fit the needs of the employees. The key here is that the employer has a fiduciary responsibility to every investment option in the plan—meaning they must choose investments that benefit the employee base—whereas with an IRA you’ll be running your own show.

•    Plans that aren’t managed well can cost more than they should. When we sign a new client and convert their 401(k), we often find that plans aren’t optimized—and in some cases, it’s worse than that. The employer and employees are often paying more for their investments than they should be, and those extra fees are costing you money. Even a small difference in cost can add up to a healthy chunk of money over time—money that should be going to employee accounts rather than advisers’ pockets.

Key takeaways for an IRA

•    Flexibility to consider different investment and distribution needs. With a wider variety of investments, costs, and service options available, IRAs are great for folks who don’t have access to a retirement plan at work. They’re also great for those who would like the additional investment choice flexibility that comes with running your own account. And when it comes time to retire, rolling any retirement balance into a personal IRA is a great idea anyway because it’s easier to access your money when you need it.

•    Tax deductibility is tenuous, especially for higher earners. If you want to save more than $6,000 per year for retirement (that’s the contribution limit for an IRA in 2022), you’ll have to save into a company 401(k) if you have that option. And if you’re a high-earner, it’s important to note that IRAs lose their tax-advantages entirely if you have a retirement plan at work and earn more than $75,000 per year ($124,000 for married couples who file taxes jointly).

•    IRAs require more attention and diligence. If you’re shopping for an IRA, it’ll take time to sift through advisers, find investments you want, and avoid the commissioned sales people offering high-cost investment options. In the same way that 401(k) costs can get out of control if they aren’t carefully watched, high-cost IRA investments can take a chunk out of your market returns—and over the long-run, high fees add up.

My advice is that saving into a 401(k) is probably the better option if your employer offers a match and you can find funds that you want to invest your money in—and it’ll probably be cheaper, too. But an IRA may be a better option in some cases, especially if there are specific funds you want to invest in or if your employer doesn’t offer you another way to save. Either way, take advantage of saving early!


103/31/1988 – 03/31/2018 Annualized Return: 8.050985%; 12/31/1987 – 12/31/2017 Annualized Return: 8.263003%


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