401(k) vs IRA: which is a better wealth management tool?  

With the many different choices, some investors may become confused when it comes to picking the right tool that can help them achieve their financial goals. Investing to grow and preserve wealth, and building a retirement nest egg are among the most crucial of these goals.  

One of the questions that may be raised is whether to use a 401(k) plan or an Individual Retirement Account (IRA) to achieve these goals. Since both investment vehicles have tax benefits and certain benefits of their own, it’s understandable why some investors are undecided or confused.  

In this article, InvestmentNews tackles important questions some investors might have, such as the advantages of a 401(k) vs an IRA and vice versa, 401(k) and IRA limits, and other relevant topics.  

Can you have both a 401(k) and an IRA? 

The simple answer? Yes. In fact, having a 401(k) along with an IRA is highly encouraged. Investors who are employees should make full use of their 401(k) if their employer offers it and open an IRA account whenever possible.  

Investors who make contributions to a 401(k) while also maintaining a traditional IRA are using an excellent strategy. Doing this boosts their retirement savings and puts more of their hard-earned money to work in tax-advantaged accounts.  

Is a 401(k) an IRA for tax purposes?  

No. Some investors may be misled into thinking that a 401(k) is a traditional IRA, possibly because both appear to have similar tax benefits. Even though both investment vehicles only have their withdrawals taxed once the funds in them are withdrawn, traditional IRAs and 401(k)s are very different as shown in the table below: 

Another shared feature is that both investment tools allow the owner to withdraw funds only after they reach the age of 59½. Their main difference is that 401(k)s are employer-sponsored, so you can only have a 401(k) plan through an employer. IRAs (traditional or Roth) are created by the individual investor via a financial institution. 

The 401(k) or IRA strategy 

Ideally, investors should use both their employer-sponsored 401(k) and their own Individual Retirement Account to make the most out of these options to build savings for a comfortable retirement.  

However, not everyone can afford to do this and have both accounts. Here’s what investors can do if: 

• their employer provides a 401(k) match 
• their employer doesn’t provide a 401(k) match 

If the employer provides a 401(k) match  

1. Make sufficient contributions to the 401(k) to get the match 

Investors should check their employee benefits handbook about the company’s 401(K) plan. It also helps to know which investments their company 401(k) offers.  

If investments are in companies that champion the investor’s causes and do some good, this may motivate them to contribute. Typically, employers will match a portion of the amount contributed to the 401(k) of up to 6%.  

Even if the company offers a limited selection of investments for 401(k), these can still be worth investing in, since these funds may charge less fees than invested outside of the plan.  

The 401(k) match doesn’t count to the yearly 401(k) contribution limit, so employees get to put in twice as much if they contribute enough to get the match.  

2. Contribute as much as possible to an IRA 

There are different scenarios for having a traditional IRA or a Roth IRA:  

• In a traditional IRA: the account owner gets an immediate tax break because contributions to it can be deductible. This means that the account owner’s taxable income for the year can be reduced by the amount contributed to the traditional IRA. If the IRA owner also has a 401(k), the deduction can be decreased or removed based on their income.  
• In a Roth IRA: the contributions are not tax-deductible, but the growth on the investments within it is not taxable. What’s more, distributions from the Roth IRA are also exempt from taxes, but only if withdrawals or distributions are made after the account owner turns 59½.  

3. Maximize the IRA, then go back to 401(k) 

After contributing to IRA accounts, investors should check if they can still contribute to their 401(k) as well. Doing so can still give the benefit of the tax deduction equal to the amount of their 401(k) contributions. And there’s the added benefit of getting more tax-deferred growth on 401(k) investment gains.  

If the employer does not give a 401(k) match 

1. Open a traditional or Roth IRA and contribute to it first 

If the company doesn’t offer the 401(k) match, investors should consider an IRA and max out the contributions to it instead. One advantage of having their own IRA is that investors now have access to a broader selection of investments that their 401(k) plan may not offer.  

Investors can scout the market for investments like ETFs and mutual funds that have the lowest fees. With an IRA, they may even dodge some of the hefty administrative fees that some 401(k) investments might charge.  

2. Max out the IRA contributions, then go back to the 401(k) 

If there’s money left over after maxing out the IRA contribution limit, then it’s worth exploiting the tax benefit of the 401(k).  

There are limits to this benefit. If a 401(k) plan holder or their spouse contributes to a workplace plan and the combined income surpasses certain thresholds, deductions of traditional IRA contributions from taxable income may shrink or disappear completely.  

However, the plan holder may still be eligible for a Roth IRA. And even if they can no longer deduct IRA contributions, they can make non-deductible contributions and still get the benefit of tax-deferred growth on investments. The IRA can be converted to a Roth RIA to sidestep the restrictions.  

For a clearer picture of what retirement savings would be like with either a 401(k) or IRA, use a Roth IRA calculator as a guide. 

Here’s a video where the presenter discusses the 401(k) vs IRA pros and cons in a bit more detail. They mention another important factor for choosing one of the IRA types or the 401(k): the investor’s tax bracket.  

Roth IRAs are better for those who are younger and in a lower tax bracket, while 401(k)s are for high income earners who expect to be in a lower tax bracket in retirement. Watch the video for more.  

The 401(k) vs IRA Decision Guide 

401(k) vs IRA: which is better? 

The answer to this question is not always simply a choice between one or the other. However, these are about the only scenarios where one is better:  

• 401(k)s are good for: virtually any employee who can participate in the plan, especially if their employer offers the 401(k) match 
• IRAs are good for: anyone who doesn’t have a retirement account through their workplace 

So, if an investor is employed at a company that offers the 401(k) match, then it would be better to participate and contribute to the 401(k) plan. 

If an individual investor works at a company or business that offers no 401(k) plan, then investing in their own IRA is the clear winner.  

What’s more, 401(k)s are offered through employers, whereas IRAs are opened by individuals via a broker or a bank. IRAs generally afford investors more investment choices, but 401(k)s allow higher annual contributions. 

Most savvy advisors would suggest a retirement plan or strategy that uses both the 401(k) and an IRA account whenever possible. By having both retirement planning tools, investors can make the most out of their earnings and grow the biggest possible retirement fund.  

Seek out the opinions of our experts for more on 401(k) vs IRA and a comparison of other retirement planning tools.