If you have to choose, IRA vs 401k, which is better?
There are a few key differences between an IRA and a 401k. Both are great options for tax-advantaged retirement saving, as you don't pay any taxes on the growth of your investments. Read on to learn the differences between a 401k and an IRA and see which might be best for you.
IRA vs 401k
To quash one common myth, you don't have to choose between an IRA and a 401k; you can have both. If you do have the option of a 401k at work, you lose the tax deduction benefits of an IRA once your income exceeds $70,000 ($116,000 if you're married filing jointly).
Anyone who has earned income and is below the age of 70-1/2 can contribute to a traditional IRA, while only people who are employed at a company that offers a 401k can contribute to a 401k. For Roth IRAs, your contribution limit begins to decrease when your income hits reaches $114,000 ($181,000 if married filing jointly), and you're not allowed to contribute if your income is higher than $129,000 ($191,000 if married filing jointly). If your company offers a Roth 401k, there is no maximum income level.
Maximum contribution level
A 401k has a significantly higher maximum contribution level than an IRA. For 2014, the maximum contribution limits are:
IRA
|
401k
| |
|---|---|---|
Basic limit
|
$5,500
|
$17,500
|
Catch-up contribution limit for those aged 50 and older
|
$1,000
|
$5,500
|
SOURCE: IRS.
The employee contribution limits of 401ks are three times higher than those of IRAs, but with employer contributions added in, the 401k's maximum contribution can be significantly higher than an IRA's.
The main advantage of a 401k is that employers can match or otherwise contribute to an employee's 401k account. Matching varies significantly from employer to employer, so you need to see what match your employer offers, if any. The limit, including employer contributions, is about 10 times higher than the maximum contribution in an IRA.
Plan type
|
IRA
|
401k
|
|---|---|---|
Basic contribution limit
|
$5,500
|
$17,500
|
Catch-up contribution limit for those aged 50 and older
|
$1,000
|
$5,500
|
Total contribution limit for those aged 50 and older
|
$6,500
|
$23,000
|
Maximum combined contribution for employee and employer
|
N/A
|
$52,000
|
Maximum combined contribution for employee and employer for those aged 50 and older
|
N/A
|
$57,500
|
SOURCE: IRS.
For those who have the option of a 401k and an IRA, employer matching of contributions can significantly tilt the advantage toward investing with a 401k. 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 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 401k: cost and flexibility. When you leave your job, you are no longer allowed to contribute to that employer's 401k. You then have to make a choice between keeping your 401k 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.
Cost
The costs associated with a 401k vary significantly: I've seen them range from nothing to 2% annually. To quickly find out whether your 401k is high-cost compared to others, check out Brightscope's retirement plan search. To find exact details, however, it's best to look at your 401k plan's documents.
If you are in a high-cost plan, or even a low-cost plan, an IRA can cost you a whole lot less, as most have little to no annual fees. You cancompare IRA account providers here.
Flexibility
Most 401k plans offer limited investment options, with the average 401k plan offering 20 funds, according to Brightscope. While some 401(k)s now come with the option of a self-directed account -- meaning you can invest as you do with a normal brokerage account -- this is still not the norm. An IRA is more like a normal brokerage account, so your investment options are almost endless.
More questions?
The differences between IRA vs 401k accounts are not that difficult to understand. Both are great tax-advantaged ways to save for retirement. Regularly contributing to either one is a great way to grow your investments for retirement. The more you contribute, the more your assets can compound over time. You should strongly consider maxing out your contributions, especially if they are eligible for an employer match.
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