IRA vs. 401(k): What's the difference?

March 04, 2021

The three most common types of retirement investment accounts are a 401(k), traditional IRA and Roth IRA.

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.

IRA and 401(k) definitions

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.

IRA and 401(k) contributions and investment selections

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)s

  • Eligibility: Most employers have certain qualifications you must meet to participate in their 401(k) savings plan, such as being at least 21 and employed with the organization for at least one year.
  • Contribution details: 401(k) contributions are directly withdrawn from your paycheck with pre-tax dollars.
  • Annual contribution limit: The current limit is $20,500. If you’re age 50 or older you can contribute an additional $6,500 for a total of $27,000 per year.
  • Employer match: Varies by employer, with average match of 4.7%.1
  • Investment selection: Generally chosen by your employer; more than one type of portfolio may be offered.

Traditional and Roth IRAs

  • Eligibility: 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: 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: You can contribute $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: None.
  • Investment selection: You can choose the investments for your portfolio.

IRA and 401(k) taxes and withdrawals

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)s + traditional IRAs

  • Tax implications: Pre-tax or tax-deductible contributions. Withdrawals taxed as ordinary income.
  • Tax penalties for early withdrawal: 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.
  • Required minimum distributions (RMDs): 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 IRAs

  • Tax implications: 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: 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): No minimum distributions required during the Roth IRA account owner or spouse’s life. Read about distribution requirements for an inherited IRA.

Is an IRA or 401(k) better suited for your needs?

  • Consider a 401(k) if your employer offers a company match and prefer to contribute to an account with pre-tax dollars.
  • If your priority is to lower your taxable income, a traditional IRA can help with that. Whatever you contribute, your taxable income may be lowered by that amount.
  • If flexibility is a priority, consider a Roth IRA. With qualified tax-free withdrawals in retirement, no required withdrawals and the ability to withdraw your contributions at any time, Roth IRAs make cashing out easy. 

 

Diversifying your investments can lower your taxes now and into retirement. Learn more in this guide to tax diversification and investing.

Related content

Commonly asked questions about receiving Social Security benefits

How to build wealth at any age

Retirement planning in the gig economy

Retirement quiz: How ready are you?

IRA vs. 401(k): What's the difference?

Retirement planning strategies for dual-income families

Key milestone ages as you near and start retirement

Retirement expectations quiz

Unexpected retirement expenses

7 ways for pre-retirees to get ready for retirement

Retirement income planning: 4 steps to take

LGBTQ+ retirement planning: What you need to know

How to retire happy

4 tips to help you save for retirement in your 20s

Start of disclosure content

Investment and insurance products and services including annuities are:
Not a deposit ● Not FDIC insured ● May lose value ● Not bank guaranteed ● Not insured by any federal government agency.

U.S. Wealth Management – U.S. Bank | U.S. Bancorp Investments is the marketing logo for U.S. Bank and its affiliate U.S. Bancorp Investments.

The information provided represents the opinion of U.S. Bank and U.S. Bancorp Investments and is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific investment advice and should not be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation.

U.S. Bank, U.S. Bancorp Investments and their representatives do not provide tax or legal advice. Each individual's tax and financial situation is unique. You should consult your tax and/or legal advisor for advice and information concerning your particular situation.

For U.S. Bank:

U.S. Bank does not offer insurance products but may refer you to an affiliated or third party insurance provider.

U.S. Bank is not responsible for and does not guarantee the products, services or performance of U.S. Bancorp Investments, Inc.

For U.S. Bancorp Investments:

Investment and insurance products and services including annuities are available through U.S. Bancorp Investments, the marketing name for U.S. Bancorp Investments, Inc., member FINRA and SIPC, an investment adviser and a brokerage subsidiary of U.S. Bancorp and affiliate of U.S. Bank.

U.S. Bancorp Investments is registered with the Securities and Exchange Commission as both a broker-dealer and an investment adviser. To understand how brokerage and investment advisory services and fees differ, the Client Relationship Summary and Regulation Best Interest Disclosure are available for you to review.

Insurance products are available through various affiliated non-bank insurance agencies, which are U.S. Bancorp subsidiaries. Products may not be available in all states. CA Insurance License #0E24641.

Pursuant to the Securities Exchange Act of 1934, U.S. Bancorp Investments must provide clients with certain financial information. The U.S. Bancorp Investments Statement of Financial Condition is available for you to review, print and download.

The Financial Industry Regulatory Authority (FINRA) Rule 2267 provides for BrokerCheck to allow investors to learn about the professional background, business practices, and conduct of FINRA member firms or their brokers. To request such information, contact FINRA toll-free at 1-800‐289‐9999 or via https://brokercheck.finra.org. An investor brochure describing BrokerCheck is also available through FINRA.

U.S. Bancorp Investments Order Processing Information.