If you’re eligible, it’s possible you could contribute to a 401(k) and a traditional and Roth IRA, so it may be helpful to know how they compare from a contribution, withdrawal and tax perspective. Here’s a look at their similarities and differences.
A 401(k) is a type of employer-sponsored retirement plan. Depending on the industry you work in, your employer-sponsored retirement plan may be called a 403(b) or 457.
An IRA is an individual retirement account that you open with a financial institution, either a bank or a brokerage firm. Types of IRAs available include traditional IRAs, Roth IRAs and even options for self-employed individuals and small business owners.
There’s a difference in how you fund 401(k)s and traditional/Roth IRAs, as well as the investment options available to you.
401(k) vs. Traditional & Roth IRA |
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Eligibility | |
401(k) Most employers have certain qualifications you must meet to participate in their retirement plan, such as being at least 21 and employed with the organization for at least one year. |
Traditional + Roth IRA Most people are eligible to open and contribute to an IRA. For a traditional IRA, you need to have compensation. For a Roth IRA, you must meet certain contribution criteria and tax filing requirements. Read more about IRAs. |
Contribution details | |
401(k) Contributions are directly withdrawn from your paycheck with pre-tax dollars. |
Traditional + Roth IRA Roth IRAs are funded with after-tax dollars. Traditional IRAs can be funded with after-tax dollars or as tax-deductible contributions. |
Annual contribution limit | |
401(k) $20,500 per year. If you’re age 50 or older you can contribute an additional $6,500 for a total of $27,000 per year. |
Traditional + Roth IRA $6,000 per year. If you’re age 50 or older you can contribute an additional $1,000 for a total of $7,000 per year. |
Employer match details | |
401(k) Varies by employer, with an average match of 4.7%.1 |
Traditional + Roth IRA None. |
Investment selection |
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401(k) Investment options are generally chosen by your employer; more than one type of portfolio may be offered. |
Traditional + Roth IRA You can choose what goes into your portfolio. |
401(k)s and traditional IRAs have more in common when it comes to tax benefits, distribution and withdrawal requirements. They’re considered tax-advantaged investment accounts, since contributions are either pre-tax or tax-deductible.
A Roth IRA is considered a tax-free investment account, since distributions and qualified withdrawals aren’t taxed.
401(k) & Traditional IRA vs. Roth IRA |
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Tax implications | |
401(k) + Traditional IRA Pre-tax or tax-deductible contributions. Withdrawals taxed as ordinary income. |
Roth IRA Non-deductible contributions. Tax-free withdrawals on contributions; tax-free withdrawals on earnings if you’ve owned the account for five years. |
Tax penalties for early withdrawal | |
401(k) + Traditional IRA 10% penalty tax if withdrawn before age 59 ½, but certain exceptions may apply to your situation. With a traditional IRA, qualifying exceptions include first-time homebuyers, college and medical expenses. |
Roth IRA If you are younger than 59 ½, you can withdraw up to $10,000 penalty-free to pay for qualified first-time home-buyer expenses, provided at least five tax years have passed since your initial contribution. Other exceptions may apply to your situation. |
Required minimum distributions (RMDs) | |
401(k) + Traditional IRA After you reach age 72, you are required to withdraw a certain amount each year, calculated based on your age and the value of your accounts. |
Roth IRA No minimum distributions required during the Roth IRA account owner or spouse’s life. Read about distribution requirements for an inherited IRA. |
Diversifying your investments can lower your taxes now and into retirement. Learn more in this guide to tax diversification and investing.