IRA vs. 401(k) — What's the Difference?

The Core Difference

Both accounts give you tax-advantaged investing for retirement. The main differences are who sets them up, how much you can contribute, and what you can invest in.

The 401(k)

A 401(k) is a retirement account your employer sponsors. You contribute from your paycheck before taxes (traditional) or after taxes (Roth 401(k)), up to $23,500 per year in 2025.

The biggest advantage: the employer match. Many employers match a portion of what you contribute — commonly 50% of contributions up to 6% of salary, or a flat 3–4% match. This is free money and an instant 50–100% return on those dollars. Always contribute at least enough to get the full match.

The main downside: limited investment choices. Your 401(k) plan administrator chooses which funds are available. Some plans have excellent low-cost index funds; others only offer high-fee actively managed funds. You work with what you have.

The IRA

An IRA (Individual Retirement Account) is an account you open yourself at any broker — Fidelity, Vanguard, Schwab, etc. You choose exactly what to invest in, with access to the full universe of index funds, ETFs, and stocks.

The biggest advantage: full investment freedom. You're not locked into your employer's fund menu. You can buy the cheapest index funds available.

The main downside: lower contribution limits. At $7,000/year, it's a smaller bucket than the 401(k)'s $23,500.

The Right Priority Order

1. 401(k) up to the full employer match — Free money, always take it first
2. Max the Roth IRA ($7,000) — Better investment options, tax-free growth
3. Back to the 401(k) — Fill it up to the $23,500 limit
4. Taxable brokerage — Once tax-advantaged space is maxed

If you can't do all of this, stop when your budget runs out. The order matters more than the total amount.

When to Deviate From the Order

Your 401(k) has terrible funds (high expense ratios)

If your employer's plan only offers funds charging 0.8%+ per year with no good index fund options, it may be worth prioritizing the IRA over extra 401(k) contributions above the match. The fee drag can outweigh the tax benefit.

You're in a very high tax bracket

The traditional 401(k)'s immediate tax deduction is more valuable at higher income levels. If you're in the 35–37% bracket, the pre-tax 401(k) contribution saves you 35–37 cents per dollar contributed right now. That's a strong argument for filling the 401(k) first.

You have no employer match

If your employer offers no match, the 401(k)'s main advantage disappears. In that case, prioritizing the IRA for its investment flexibility is reasonable.

Traditional vs. Roth — For Both Accounts

Both 401(k)s and IRAs have traditional (pre-tax) and Roth (after-tax) versions. The same logic applies to both:

• Earlier career, lower income now → Roth
• Peak earning years, high bracket now → Traditional
• Not sure → Roth, or split between both

Many people end up with a mix of traditional and Roth accounts, which gives flexibility in retirement to withdraw from whichever is most tax-efficient in a given year.

What Happens When You Leave a Job?

Your 401(k) stays with the employer's plan, but you have options:

• Leave it there — fine if the plan has good funds
• Roll it to your new employer's 401(k) — consolidates accounts
• Roll it to an IRA — gives you full investment freedom, often the best option
• Cash it out — almost never the right move (income taxes + 10% penalty if under 59½)

FAQ

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

Yes. Most people should. The accounts are independent and you can max both in the same year.

What if I'm self-employed?

Self-employed people can open a Solo 401(k) or SEP-IRA, which have much higher contribution limits than standard IRAs. A Solo 401(k) allows up to $69,000/year in 2025 (employee + employer contributions combined).

What's the difference between a rollover IRA and a regular IRA?

A rollover IRA is just a traditional IRA that received a rollover from a 401(k) or other employer plan. Functionally identical — it's more of an origin label than a different account type.